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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology

(1347 questions)

[Fact Pattern #1] The management and employees of a large household goods moving company decided to adopt total quality management (TQM) and continuous improvement (CI). They believed that, if their company became nationally known as adhering to TQM and CI, one result would be an increase in the companys profits and market share. [1] Gleim #: 1.1 -- Source: CIA 1195 III-12 (Refers to Fact Pattern #1) The primary reason for adopting TQM was to achieve

A. B. C. D.

Greater customer satisfaction. Reduced delivery time. Reduced delivery charges. Greater employee participation. Answer (A) is correct. TQM is an integrated system that anticipates, meets, and exceeds customers needs, wants, and expectations. Answer (B) is incorrect because reduced delivery time is one of many potential activities that need improvement. Answer (C) is incorrect because reduced delivery charges is one of many potential activities that need improvement. Answer (D) is incorrect because increased employee participation is necessary to achieve TQM, but it is not the primary purpose for establishing the program.

[2] Gleim #: 1.2 -- Source: CIA 1195 III-13 (Refers to Fact Pattern #1) Quality is achieved more economically if the company focuses on

A. B. C. D.

Appraisal costs. Prevention costs. Internal failure costs. External failure costs. Answer (A) is incorrect because prevention is ordinarily less costly than the combined costs of appraisal, internal failure, and external failure. Answer (B) is correct. Prevention attempts to avoid defective output. Prevention costs include preventive maintenance, employee training, review of equipment design, and evaluation of suppliers. Prevention is less costly than detection and correction of defective output. Answer (C) is incorrect because prevention is ordinarily less costly than the combined costs of appraisal, internal failure, and external failure. Answer (D) is incorrect because prevention is ordinarily less costly than the combined costs of appraisal, internal failure, and external failure.

[3] Gleim #: 1.3 -- Source: CIA 1195 III-28 A traditional quality control process in manufacturing consists of mass inspection of goods only at the end of a production process. A major deficiency of the traditional control process is that

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

A. B. C. D.

It is expensive to do the inspections at the end of the process. It is not possible to rework defective items. It is not 100% effective. It does not focus on improving the entire production process. Answer (A) is incorrect because other quality control processes can also be expensive. Answer (B) is incorrect because reworking defective items may be possible although costly. Answer (C) is incorrect because no quality control system will be 100% effective. Answer (D) is correct. The process used to produce the goods is not thoroughly reviewed and evaluated for efficiency and effectiveness. Preventing defects and increasing efficiency by improving the production process raises quality standards and decreases costs.

[4] Gleim #: 1.4 -- Source: CIA 1196 III-24 Under a total quality management (TQM) approach

A. B. C. D.

Measurement occurs throughout the process, and errors are caught and corrected at the source. Quality control is performed by highly trained inspectors at the end of the production process. Upper management assumes the primary responsibility for the quality of the products and services. A large number of suppliers are used in order to obtain the lowest possible prices. Answer (A) is correct. Total quality management emphasizes quality as a basic organizational function. TQM is the continuous pursuit of quality in every aspect of organizational activities. One of the basic tenets of TQM is doing it right the first time. Thus, errors should be caught and corrected at the source. Answer (B) is incorrect because total quality management emphasizes discovering errors throughout the process, not inspection of finished goods. Answer (C) is incorrect because all members of the organization assume responsibility for quality of the products and services. Answer (D) is incorrect because the total quality management philosophy recommends limiting the number of suppliers to create a strong relationship.

[5] Gleim #: 1.5 -- Source: CIA 596 III-29 Which of the following is a characteristic of total quality management (TQM)?

A. B. C. D.

Management by objectives. On-the-job training by other workers. Quality by final inspection. Education and self-improvement. Answer (A) is incorrect because one of the 14 points recommends elimination of numerical quotas. MBO causes aggressive pursuit of numerical quotas. Answer (B) is incorrect because informal learning from coworkers serves to entrench bad work habits. One of the 14 points stresses proper training of everyone. Answer (C) is incorrect because another of the 14 points states that quality by final inspection is unnecessary if quality is built in from the start. Answer (D) is correct. According to management theorist W. Edwards Demings well-known 14 points, education and self-improvement are essential. Knowledge is opportunity. Hence, continuous improvement should be everyones primary career objective.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

[6] Gleim #: 1.6 -- Source: CIA 596 III-30 In which of the following organizational structures does total quality management (TQM) work best?

A. B. C. D.

Hierarchal. Teams of people from the same specialty. Teams of people from different specialties. Specialists working individually. Answer (A) is incorrect because hierarchal organization stifles TQM. Answer (B) is incorrect because TQM works best with teams of people from different specialties. Answer (C) is correct. TQM advocates replacement of the traditional hierarchal structure with teams of people from different specialties. This change follows from TQMs emphasis on empowering employees and teamwork. Employees should have proper training, necessary information, and the best tools; be fully engaged in the decision process; and receive fair compensation. If such empowered employees are assembled in teams of individuals with the required skills, TQM theorists believe they will be more effective than people performing their tasks separately in a rigid structure. Answer (D) is incorrect because teamwork is essential for TQM.

[7] Gleim #: 1.7 -- Source: CIA 1196 III-23 The most important component of quality control is

A. B. C. D.

Ensuring goods and services conform to the design specifications. Satisfying upper management. Conforming with ISO-9000 specifications. Determining the appropriate timing of inspections. Answer (A) is correct. The intent of quality control is to ensure that goods and services conform to the design specifications. Whether the focus is on feedforward, feedback, or concurrent control, the emphasis is on ensuring product or service conformity. Answer (B) is incorrect because quality control is geared towards satisfying the customer, not upper management. Answer (C) is incorrect because ensuring the conformance with ISO-9000 specifications is a component of a compliance audit, not quality control. Answer (D) is incorrect because determining the appropriate timing of inspections is only one step towards approaching quality control. Consequently, it is not the primary component of the quality control function.

[8] Gleim #: 1.8 -- Source: CMA 1296 3-22 The cost of scrap, rework, and tooling changes in a product quality cost system is categorized as a(n)

A. B. C. D.

Training cost. External failure cost. Internal failure cost. Prevention cost.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

Answer (A) is incorrect because training costs are prevention costs. Answer (B) is incorrect because the costs of external failure, such as warranty expense, product liability, and customer ill will, arise when problems are discovered after products have been shipped. Answer (C) is correct. Internal failure costs are incurred when detection of defective products occurs before shipment. Examples of internal failure costs are scrap, rework, tooling changes, and downtime. Answer (D) is incorrect because prevention costs are incurred to avoid defective output. Examples include preventive maintenance, employee training, review of equipment design, and evaluation of suppliers. [9] Gleim #: 1.9 -- Source: CMA 1295 3-12 The four categories of costs associated with product quality costs are

A. B. C. D.

External failure, internal failure, prevention, and carrying. External failure, internal failure, prevention, and appraisal. External failure, internal failure, training, and appraisal. Warranty, product liability, training, and appraisal. Answer (A) is incorrect because carrying cost is not one of the elements of quality costs. Answer (B) is correct. The following are the four categories of quality costs: prevention, appraisal, internal failure, and external failure (lost opportunity). Costs of prevention include attempts to avoid defective output, including employee training, review of equipment design, preventive maintenance, and evaluation of suppliers. Appraisal costs include quality control programs, inspection, and testing. Internal failure costs are incurred when detection of defective products occurs before shipment, including scrap, rework, tooling changes, and downtime. External failure costs are incurred after the product has been shipped, including the costs associated with warranties, product liability, and customer ill will. Answer (C) is incorrect because training costs are not a category of quality costs. Answer (D) is incorrect because warranty, product liability, and training are not cost categories identified by SMA 4R.

[10] Gleim #: 1.10 -- Source: CMA 1295 3-14 The cost of statistical quality control in a product quality cost system is categorized as a(n)

A. B. C. D.

Internal failure cost. Training cost. External failure cost. Appraisal cost. Answer (A) is incorrect because internal failure costs arise after poor quality has been found; statistical quality control is designed to detect quality problems. Answer (B) is incorrect because statistical quality control is not a training cost. Answer (C) is incorrect because external failure costs are incurred after the product has been shipped, including the costs associated with warranties, product liability, and customer ill will. Answer (D) is correct. The following are the four categories of quality costs: prevention, appraisal, internal failure, and external failure (lost opportunity). Appraisal costs include quality control programs, inspection, and testing. However, some authorities regard statistical quality and process control as preventive activities because they not only detect faulty work but also allow for adjustment of processes to avoid future defects.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

[11] Gleim #: 1.11 -- Source: CMA 697 3-28 Listed below are selected line items from the cost-of-quality report for Watson Products for last month. Category Rework Equipment maintenance Product testing Product repair Amount $ 725 1,154 786 695

What is Watsons total prevention and appraisal cost for last month?

A. B. C. D.

$786 $1,154 $1,940 $2,665 Answer (A) is incorrect because $786 is the appraisal cost. Answer (B) is incorrect because $1,154 is the prevention cost. Answer (C) is correct. The costs of prevention and appraisal are conformance costs that serve as financial measures of internal performance. Prevention costs are incurred to prevent defective output. These costs include preventive maintenance, employee training, review of equipment design, and evaluation of suppliers. Appraisal costs are incurred to detect nonconforming output. They embrace such activities as statistical quality control programs, inspection, and testing. The equipment maintenance cost of $1,154 is a prevention cost. The product testing cost of $786 is an appraisal cost. Their sum is $1,940. Answer (D) is incorrect because $2,665 includes rework, an internal failure cost.

[12] Gleim #: 1.12 -- Source: CMA 697 3-27 All of the following are generally included in a cost-of-quality report except

A. B. C. D.

Warranty claims. Design engineering. Supplier evaluations. Lost contribution margin. Answer (A) is incorrect because the costs of warranty claims are readily measurable external failure costs captured by the accounting system. Answer (B) is incorrect because the cost of design engineering is a prevention cost that is usually included in cost-ofquality reports. Answer (C) is incorrect because the cost of supplier evaluations is a prevention cost that is usually included in cost-ofquality reports. Answer (D) is correct. A cost-of-quality report includes most costs related to quality, including the costs of external failure, internal failure, prevention, and appraisal. Lost contribution margins from poor product quality are external failure costs that normally do not appear on a cost-of-quality report because they are opportunity costs. Opportunity costs are not usually recorded by the accounting system, thereby understating the costs of poor quality. Lost contribution margins from reduced sales, market share, and sales prices are external failure costs that are also not usually included in a cost-of-quality report.

[13] Gleim #: 1.13 -- Source: Publisher Conformance is how well a product and its components meet applicable standards. According to the robust quality concept,

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

A. B. C. D.

A certain percentage of defective units is acceptable. Units are acceptable if their characteristics lie within an acceptable range of values. The goal is for all units to be within specifications. Every unit should reach a target value. Answer (A) is incorrect because the traditional view of quality treats a certain number of defective units as acceptable. Answer (B) is incorrect because the traditional view of quality deems that a unit is acceptable if it is within a range of specified values. Answer (C) is incorrect because the robust quality concept is an extension of the zero-defects approach. The goal of robust quality is in every case to reach a target value, not merely a range of acceptable values. Answer (D) is correct. Conformance is how well a product and its components meet applicable standards. The traditional view is that conforming products are those with characteristics that lie within an acceptable specified range of values that includes a target value. This view also regarded a certain percentage of defective (nonconforming) units as acceptable. The traditional view was superseded by the zero-defects approach that sought to eliminate all nonconforming output. An extension of this approach is the robust quality concept. Its goal is to reach the target value in every case. The reason is that hidden quality costs occur when output varies from the target even though the units are within specifications.

[14] Gleim #: 1.14 -- Source: Publisher The Plan-Do-Check-Act (PDCA) Cycle is a quality tool devised by W.E. Deming. It is best described as

A. B. C. D.

A management by fact approach to continuous improvement. An ongoing evaluation of the practices of best-in-class organizations. The translation of customer requirements into design requirements. The responsibility of every employee, work group, department, or supplier to inspect the work. Answer (A) is correct. PDCA is a management by fact or scientific method approach to continuous improvement. PDCA creates a process-centered environment because it involves studying the current process, collecting and analyzing data to identify causes of problems, planning for improvement, and deciding how to measure improvement (Plan). The plan is then implemented on a small scale if possible (Do). The next step is to determine what happened (Check). If the experiment was successful, the plan is fully implemented (Act). The cycle is then repeated using what was learned from the preceding cycle. Answer (B) is incorrect because competitive benchmarking is an ongoing evaluation of the practices of best-in-class organizations. Answer (C) is incorrect because quality deployment is the translation of customer requirements into design requirements. Answer (D) is incorrect because the quality at the source concept emphasizes the responsibility of every employee, work group, department, or supplier to inspect the work.

[15] Gleim #: 1.15 -- Source: Publisher Which of the following quality costs are nonconformance costs?

A. B. C. D.

Systems development costs. Costs of inspecting in-process items. Environmental costs. Costs of quality circles.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

Answer (A) is incorrect because systems development costs are prevention (conformance) costs. Answer (B) is incorrect because costs of inspecting in-process items are appraisal (conformance) costs. Answer (C) is correct. Nonconformance costs include internal and external failure costs. External failure costs include environmental costs, e.g., fines for violations of environmental laws and loss of customer goodwill. Answer (D) is incorrect because costs of quality circles are prevention (conformance) costs. [16] Gleim #: 1.16 -- Source: Publisher Quality costing is similar in service and manufacturing organizations. Nevertheless, the differences between these organizations have certain implications for quality management. Thus,

A. Direct labor costs are usually a higher percentage of total costs in manufacturing organizations. B. External failure costs are relatively greater in service organizations. C. Quality improvements resulting in more efficient use of labor time are more likely to be accepted by employees in service organizations. D. Poor service is less likely to result in loss of customers than a faulty product. Answer (A) is incorrect because direct labor costs are usually a higher percentage of total costs in service organizations. Answer (B) is correct. External failure costs arise when problems occur after delivery. They occur because products or services are nonconforming or otherwise do not satisfy customers. External failure costs in service enterprises are even more important than in manufacturing environments. Faulty goods sometimes may be reworked or replaced to a customers satisfaction, but poor service tends to result in a loss of customers. Answer (C) is incorrect because service activities are usually more labor intensive than in modern manufacturing environments. Thus, more efficient labor usage is more likely to be viewed as a threat to employee job security in service organizations. Answer (D) is incorrect because the badwill resulting from poor service may be even more likely than a defective product to result in loss of customers. [17] Gleim #: 1.17 -- Source: Publisher An organization has adopted the robust quality approach. According to this view of quality,

A. The minimum point on the total quality cost curve occurs when conformance cost per unit equals nonconformance cost per unit. B. Improving quality requires tradeoffs among categories of quality costs. C. Beyond some point, incurrence of prevention and appraisal costs is not cost beneficial. D. Costs in all categories of quality costs may be reduced while improving quality.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

Answer (A) is incorrect because, according to the robust quality concept, conformance costs do not necessarily have to continue to increase to obtain additional reductions in nonconformance costs. Answer (B) is incorrect because, according to the robust quality concept, conformance costs do not necessarily have to continue to increase to obtain additional reductions in nonconformance costs. Answer (C) is incorrect because, according to the robust quality concept, conformance costs do not necessarily have to continue to increase to obtain additional reductions in nonconformance costs. Answer (D) is correct. The optimal level of quality costs traditionally has been deemed to occur where the conformance cost curve intercepts the nonconformance cost curve, which corresponds to the minimum point on the total cost curve. Thus, beyond some point, incurrence of prevention and appraisal costs is not cost beneficial. However, the modern robust quality view is that this relationship does not always hold. Improving quality and reducing costs in each category may be possible if the most efficient prevention methods are applied. For example, selection of a supplier meeting high quality standards regarding defect rates and delivery times may drive down not only failure costs but also the prevention and appraisal costs incurred when supplier performance was less reliable. Thus, conformance costs do not have to continue to increase to obtain additional reductions in nonconformance costs. [18] Gleim #: 1.18 -- Source: CMA 693 4-28 When evaluating projects, breakeven time is best described as

A. B. C. D.

Annual fixed costs monthly contribution margin. Project investment annual net cash inflows. The point at which cumulative cash inflows on a project equal total cash outflows. The point at which discounted cumulative cash inflows on a project equal discounted total cash outflows. Answer (A) is incorrect because it is related to breakeven point, not breakeven time. Answer (B) is incorrect because the payback period equals investment divided by annual undiscounted net cash inflows. Answer (C) is incorrect because the payback period is the period required for total undiscounted cash inflows to equal total undiscounted cash outflows. Answer (D) is correct. Breakeven time evaluates the rapidity of new product development. The usual calculation determines the period beginning with project approval that is required for the discounted cumulative cash inflows to equal the discounted cumulative cash outflows. However, it may also be calculated as the point at which discounted cumulative cash inflows on a project equal discounted total cash outflows. The concept is similar to the payback period, but it is more sophisticated because it incorporates the time value of money. It also differs from the payback method because the period covered begins at the outset of a project, not when the initial cash outflow occurs.

[19] Gleim #: 1.19 -- Source: CIA 594 III-56 Management of a company is attempting to build a reputation as a world-class manufacturer of quality products. Which of the following measures would not be used by the firm to measure quality?

A. B. C. D.

The percentage of shipments returned by customers because of poor quality. The number of parts shipped per day. The number of defective parts per million. The percentage of products passing quality tests the first time.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

Answer (A) is incorrect because the percentage of shipments returned measures quality by the number of defective units. Answer (B) is correct. The number of parts shipped per day would most likely be used as a measure of the effectiveness and efficiency of shipping procedures, not the quality of the product. This measure does not consider how many of the parts are defective. Answer (C) is incorrect because the number of defective parts per million measures quality by the number of defective units. Answer (D) is incorrect because the percentage of products passing quality tests the first time measures quality by the number of nondefective products. [20] Gleim #: 1.20 -- Source: CMA 694 3-16 In year 2, a manufacturing company instituted a total quality management (TQM) program producing the following report: Summary Cost of Quality Report (000s) Year 1 Prevention costs Appraisal costs Internal failure costs External failure costs Total quality costs $ 200 210 190 1,200 $1,800 Year 2 $ 300 315 114 621 $1,350 % Change +50 +50 40 48 25

On the basis of this report, which one of the following statements is most likely true?

A. An increase in conformance costs resulted in a higher quality product and therefore resulted in a decrease in nonconformance costs. B. An increase in inspection costs was solely responsible for the decrease in quality costs. C. Quality costs such as scrap and rework decreased by 48%. D. Quality costs such as returns and repairs under warranty decreased by 40%. Answer (A) is correct. TQM emphasizes the suppliers relationship with the customer, and recognizes that everyone in a process is at some time a customer or supplier of someone else, either within or outside the organization. The costs of quality include costs of conformance and costs of nonconformance. Costs of conformance include prevention costs and appraisal (inspection) costs. Nonconformance costs are composed of internal failure costs and external failure costs, such as lost opportunity. Conformance costs (prevention and appraisal) increased substantially, whereas the nonconformance costs (internal and external failure) decreased. Hence, the increase in conformance costs resulted in a higher quality product. Answer (B) is incorrect because prevention costs also increased substantially, which could also have led to higher quality products. Answer (C) is incorrect because scrap and rework are internal failure costs, which decreased by 40%. Answer (D) is incorrect because returns and repairs are external failure costs, which decreased by 48%.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

[21] Gleim #: 1.21 -- Source: CIA 1195 III-98 Quality cost indices are often used to measure and analyze the cost of maintaining a given level of quality. One example of a quality cost index, which uses a direct labor base, is computed as

The following quality cost data were collected for May and June: May Prevention costs Appraisal costs Internal failure costs External failure costs Direct labor costs $ 4,000 6,000 12,000 14,000 90,000 June $ 5,000 5,000 15,000 11,000 100,000

Based upon these cost data, the quality cost index

A. B. C. D.

Decreased 4 points from May to June. Was unchanged from May to June. Increased 10 points from May to June. Decreased 10 points from May to June. Answer (A) is correct. The index for May was 40% [($4,000 + $6,000 + $12,000 + $14,000) $90,000], and the index for June was 36% [($5,000 + $5,000 + $15,000 + $11,000) $100,000]. Answer (B) is incorrect because the index decreased. Answer (C) is incorrect because the increase in prevention costs was 10% of the increase in labor costs. Answer (D) is incorrect because the decrease in appraisal costs was 10% of the increase in labor costs.

[Fact Pattern #2]

Wolk Corporation is a highly automated manufacturing firm. The vice president of finance has decided that traditional standards are inappropriate for performance measures in an automated environment. Labor is insignificant in terms of the total cost of production and tends to be fixed, material quality is considered more important than minimizing material cost, and customer satisfaction is the number one priority. As a result, delivery performance measures have been chosen to evaluate performance.

The following information is considered typical of the time involved to complete orders: Wait time: - From order being placed to start of production - From start of production to completion Inspection time Process time Move time

10.0 days 5.0 days 1.5 days 3.0 days 2.5 days

[22] Gleim #: 1.22 -- Source: CMA 693 3-17 (Refers to Fact Pattern #2) What is the manufacturing cycle efficiency for this order?

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

A. B. C. D.

25.0%. 13.6%. 37.5%. 69.2%. Answer (A) is correct. Manufacturing cycle efficiency is defined as the quotient of the time required for value-added production divided by total manufacturing lead time. For this order, the total lead time is 12 days (5.0 + 1.5 + 3.0 + 2.5), and the manufacturing cycle efficiency is 25% (3 days of processing 12). Answer (B) is incorrect because 13.6% includes the 10 days prior to production in the denominator, a period not included in the calculation of manufacturing cycle efficiency. Answer (C) is incorrect because inspection time and move time should be included in the denominator. Answer (D) is incorrect because the calculation involves dividing the 3 days of processing time by the total of 12 days to complete production.

[23] Gleim #: 1.23 -- Source: CMA 693 3-18 (Refers to Fact Pattern #2) What is the delivery cycle time for this order?

A. B. C. D.

7 days. 12 days. 15 days. 22 days. Answer (A) is incorrect because 7 days excludes the wait time. Answer (B) is incorrect because 12 days ignores the 10 days of the waiting period prior to the start of production. Answer (C) is incorrect because 15 days incorporates the wait time but not the production periods. Answer (D) is correct. The delivery cycle time is defined as the entire time from receipt of the order until delivery of the order. This period equals 22 days (10.0 + 5.0 + 1.5 + 3.0 + 2.5)

[24] Gleim #: 1.24 -- Source: Publisher Quality Company produces a component of a machine. The target value for a key dimension of the component is 100 millimeters (mm). The quality loss per unit if the key dimension is measured at precisely the upper or lower specification limit (100 mm 1 mm) is estimated to be $10. The following are the measures of a sample of four units: Unit 1 2 3 4 Measurement 99.0 101.0 99.5 100.5

The Quality Company produces 1,000 of the components. Based on the sample, the estimated quality loss is

A. B. C. D.

$625 $6,250 $10,000 $25,000

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
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Answer (A) is incorrect because $625 equals $.625 times 1,000 units. Answer (B) is correct. The quality loss constant (k) in the Taguchi quality loss function equation is $10 [$10 loss at the specification limit (1 mm)]. Accordingly, the quality loss for the sample may be determined as follows: Measurement in mm 99.0 101.0 99.5 100.5 Actual Target (x T) 1 +1 .5 +.5

Unit 1 2 3 4

(x T)2 1.00 1.00 .25 .25 2.50

k(x T)2 $10.00 10.00 2.50 2.50 $25.00

The average per unit quality loss for the sample is $6.25 ($25 4). Consequently, the total estimated loss for 1,000 components is $6,250. Answer (C) is incorrect because $10,000 equals $10 times 1,000 units. Answer (D) is incorrect because $25,000 is based on the total loss for the sample ($25), not the unit average loss ($6.25). [25] Gleim #: 1.25 -- Source: Publisher Which of the following statements regarding benchmarking is false?

A. Benchmarking involves continuously evaluating the practices of best-in-class organization and adapting company processes to incorporate the best of these practices. B. Benchmarking, in practice, usually involves a companys formation of benchmarking teams. C. Benchmarking is an ongoing process that entails quantitative and qualitative measurement of the difference between the companys performance of an activity and the performance by the best in the world or the best in the industry. D. The benchmarking organization against which a firm is comparing itself must be a direct competitor. Answer (A) is incorrect because they are true statements about benchmarking. Answer (B) is incorrect because they are true statements about benchmarking. Answer (C) is incorrect because they are true statements about benchmarking. Answer (D) is correct. Benchmarking is an ongoing process that entails quantitative and qualitative measurement of the difference between the companys performance of an activity and the performance by a best-in-class organization. The benchmarking organization against which a firm is comparing itself need not be a direct competitor. The important consideration is that the benchmarking organization be an outstanding performer in its industry. [26] Gleim #: 1.26 -- Source: CIA 595 III-22 An example of an internal nonfinancial benchmark is

A. B. C. D.

The labor rate of comparably skilled employees at a major competitors plant. The average actual cost per pound of a specific product at the companys most efficient plant. A $50,000 limit on the cost of employee training programs at each of the companys plants. The percentage of customer orders delivered on time at the companys most efficient plant.

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
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Answer (A) is incorrect because the labor rate of a competitor is a financial benchmark. Answer (B) is incorrect because the cost per pound of a product at the companys most efficient plant is a financial benchmark. Answer (C) is incorrect because the cost of a training program is a financial benchmark. Answer (D) is correct. Benchmarking is a continuous evaluation of the practices of the best organizations in their class and the adaptation of processes to reflect the best of these practices. It requires analysis and measurement of key outputs against those of the best organizations. This procedure also involves identifying the underlying key actions and causes that contribute to the performance difference. The percentage of orders delivered on time at the companys most efficient plant is an example of an internal nonfinancial benchmark. [27] Gleim #: 1.27 -- Source: Publisher Managerial performance may be measured in many ways. For example, an internal nonfinancial measure is

A. B. C. D.

Market share. Delivery performance. Customer satisfaction. Manufacturing lead time. Answer (A) is incorrect because market share is an external nonfinancial measure. Answer (B) is incorrect because delivery performance is an external nonfinancial measure. Answer (C) is incorrect because customer satisfaction is an external nonfinancial measure. Answer (D) is correct. Feedback regarding managerial performance may take the form of financial and nonfinancial measures that may be internally or externally generated. Moreover, different measures have a long-term or short-term emphasis. Examples of internal nonfinancial measures are product quality, new product development time, and manufacturing lead time (cycle time).

[28] Gleim #: 1.28 -- Source: CIA 597 III-14 Which of the following criteria would be most useful to a sales department manager in evaluating the performance of the managers customer-service group?

A. B. C. D.

The customer is always right. Customer complaints should be processed promptly. Employees should maintain a positive attitude when dealing with customers. All customer inquiries should be answered within 7 days of receipt. Answer (A) is incorrect because customer orientation is difficult to quantify. Answer (B) is incorrect because the standard specified is vague. Answer (C) is incorrect because no measure of a positive attitude has been specified for the employee. Answer (D) is correct. A criterion that requires all customer inquiries to be answered within 7 days of receipt permits accurate measurement of performance. The quantitative and specific nature of the appraisal using this standard avoids the vagueness, subjectivity, and personal bias that may afflict other forms of personnel evaluations.

[29] Gleim #: 1.29 -- Source: CIA 597 III-3 Focusing on customers, promoting innovation, learning new philosophies, driving out fear, and providing extensive training are all elements of a major change in organizations. These elements are aimed primarily at

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Gleim's CIA Test Prep: Part III: Business Analysis and Information Technology
(1347 questions)

A. B. C. D.

Copying leading organizations to better compete with them. Focusing on the total quality of products and services. Being efficient and effective at the same time, in order to indirectly affect profits. Managing costs of products and services better, in order to become the low-cost provider. Answer (A) is incorrect because competitive benchmarking is just one tool for implementing TQM. Answer (B) is correct. TQM is a comprehensive approach to quality. It treats the pursuit of quality as a basic organizational function that is as important as production or marketing. TQM is the continuous pursuit of quality in every aspect of organizational activities through a philosophy of doing it right the first time, employee training and empowerment, promotion of teamwork, improvement of processes, and attention to satisfaction of customers, both internal and external. TQM emphasizes the suppliers relationship with the customer, identifies customer needs, and recognizes that everyone in a process is at some time a customer or supplier of someone else, either within or without the organization. Answer (C) is incorrect because TQMs primary focus is not profitability. Answer (D) is incorrect because TQMs primary focus is not cost reduction.

[30] Gleim #: 1.30 -- Source: CIA 597 III-4 Total quality management in a manufacturing environment is best exemplified by

A. B. C. D.

Identifying and reworking production defects before sale. Designing the product to minimize defects. Performing inspections to isolate defects as early as possible. Making machine adjustments periodically to reduce defects. Answer (A) is incorrect because TQM emphasizes prevention, not rework. The approach of TQM is to build in and design in quality, not to fix it in or inspect it in. Answer (B) is correct. Total quality management emphasizes quality as a basic organizational function. TQM is the continuous pursuit of quality in every aspect of organizational activities. One of the basic tenets of TQM is doing it right the first time. Thus, errors should be caught and corrected at the source, and quality should be built in (designed in) from the start. Answer (C) is incorrect because TQM emphasizes prevention, not inspection. The approach of TQM is to build in and design in quality, not to fix it in or inspect it in. Answer (D) is incorrect because TQM emphasizes prevention, not adjustment. The approach of TQM is to build in and design in quality, not to fix it in or inspect it in.

[31] Gleim #: 1.31 -- Source: CIA 597 III-24 One of the main reasons that implementation of a total quality management program works better through the use of teams is

A. B. C. D.

Teams are more efficient and help an organization reduce its staffing. Employee motivation is always higher for team members than for individual contributors. Teams are a natural vehicle for sharing ideas, which leads to process improvement. The use of teams eliminates the need for supervision, thereby allowing a company to reduce staffing.

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Answer (A) is incorrect because teams are often inefficient and costly. Answer (B) is incorrect because high motivation does not directly affect the process improvement that is the key to quality improvement. Answer (C) is correct. TQM promotes teamwork by modifying or eliminating traditional (and rigid) vertical hierarchies and instead forming flexible groups of specialists. Quality circles, cross-functional teams, and self-managed teams are typical formats. Teams are an excellent vehicle for encouraging the sharing of ideas and removing process improvement obstacles. Answer (D) is incorrect because the use of teams with less supervision and reduced staffing may be by-products of TQM, but they are not ultimate objectives. [32] Gleim #: 1.32 -- Source: CIA 1195 III-28 A traditional quality control process in manufacturing consists of mass inspection of goods only at the end of a production process. A major deficiency of the traditional control process is that

A. B. C. D.

It is expensive to do the inspections at the end of the process. It is not possible to rework defective items. It is not 100% effective. It does not focus on improving the entire production process. Answer (A) is incorrect because other quality control processes can also be expensive. Answer (B) is incorrect because reworking defective items may be possible although costly. Answer (C) is incorrect because no quality control system will be 100% effective. Answer (D) is correct. The process used to produce the goods is not thoroughly reviewed and evaluated for efficiency and effectiveness. Preventing defects and increasing efficiency by improving the production process raises quality standards and decreases costs.

[Fact Pattern #3] Listed below are costs of quality that a manufacturing company has incurred throughout its operations. The company plans to prepare a report that classifies these costs into the following four categories: preventive costs, appraisal costs, internal failure costs, and external failure costs.

Cost Items Design reviews Finished goods returned due to failure Freight on replacement finished goods Labor inspection during manufacturing Labor inspection of raw materials Manufacturing product-testing labor Manufacturing rework labor and overhead Materials used in warranty repairs Process engineering Product-liability claims Product-testing equipment Repairs to equipment due to breakdowns Scheduled equipment maintenance Scrap material Training of manufacturing workers

Amount $275,000 55,000 27,000 75,000 32,000 63,000 150,000 68,000 180,000 145,000 35,000 22,000 90,000 125,000 156,000

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[33] Gleim #: 1.33 -- Source: CIA 597 III-96 (Refers to Fact Pattern #3) The costs of quality that are incurred in detecting units of product that do not conform to product specifications are referred to as

A. B. C. D.

Preventive costs. Appraisal costs. Internal failure costs. External failure costs. Answer (A) is incorrect because prevention attempts to avoid defective output, e.g., by employee training, review of equipment design, preventive maintenance, and evaluation of suppliers. Answer (B) is correct. The categories of quality costs include conformance costs (prevention and appraisal) and nonconformance costs (internal failure and external failure). Appraisal costs embrace such activities as statistical quality control programs, inspection, and testing. Thus, the cost of detecting nonconforming products is an appraisal cost. Answer (C) is incorrect because internal failure costs are incurred when detection of defective products occurs before shipment, including scrap, rework, tooling changes, and downtime. Answer (D) is incorrect because external failure costs are incurred after shipment, including the costs associated with warranties, product liability, and loss of customer goodwill.

[34] Gleim #: 1.34 -- Source: CIA 597 III-97 (Refers to Fact Pattern #3) The dollar amount of the costs of quality classified as preventive costs for the manufacturing firm would be

A. B. C. D.

$643,000 $701,000 $736,000 $768,000 Answer (A) is incorrect because $643,000 omits scheduled equipment maintenance and includes labor inspection of raw materials (an appraisal cost). Answer (B) is correct. Prevention attempts to avoid defective output, e.g., by employee training, review of equipment design, preventive maintenance, and evaluation of suppliers. Accordingly, the preventive costs equal $701,000 ($275,000 design reviews + $180,000 process engineering + $90,000 scheduled maintenance + $156,000 training). Answer (C) is incorrect because $736,000 includes the cost of product testing equipment (an appraisal cost). Answer (D) is incorrect because $768,000 includes the cost of product testing equipment and labor inspection of raw materials. Both costs are appraisal costs.

[35] Gleim #: 1.35 -- Source: CIA 597 III-23 Which of the following is a key to successful total quality management?

A. B. C. D.

Training quality inspectors. Focusing intensely on the customer. Creating appropriate hierarchies to increase efficiency. Establishing a well-defined quality standard, then focusing on meeting it.

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Answer (A) is incorrect because total quality management (TQM) de-emphasizes specialized quality inspectors. Answer (B) is correct. TQM emphasizes satisfaction of customers, both internal and external. TQM considers the suppliers relationship with the customer, identifies customer needs, and recognizes that everyone in a process is at some time a customer or supplier of someone else, either within or without the organization. Thus, TQM begins with external customer requirements, identifies internal customer-supplier relationships and requirements, and establishes requirements for external suppliers. Answer (C) is incorrect because centralization often needs to be reduced to implement a TQM process. Answer (D) is incorrect because TQM involves continuous improvement; once a standard is reached, continuous improvement requires its constant reevaluation. [36] Gleim #: 1.36 -- Source: CIA 597 III-20 One of the main reasons total quality management (TQM) can be used as a strategic weapon is that

A. B. C. D.

The cumulative improvement from a companys TQM efforts cannot readily be copied by competitors. Introducing new products can lure customers away from competitors. Reduced costs associated with better quality can support higher shareholder dividends. TQM provides a comprehensive planning process for a business. Answer (A) is correct. TQM is a comprehensive approach to quality. It treats the pursuit of quality as a basic organizational function that is as important as production or marketing. Because TQM affects every aspect of the organizations activities, it permeates the organizational culture. Thus, the cumulative effect of TQMs continuous improvement process can attract and hold customers and cannot be duplicated by competitors. Answer (B) is incorrect because new products can be quickly copied by competitors and therefore do not provide a sustained competitive advantage. Answer (C) is incorrect because TQM does not focus solely on cost reduction. Answer (D) is incorrect because TQM is only one tool of strategic management.

[37] Gleim #: 1.37 -- Source: Publisher Using the balanced scorecard approach, an organization evaluates managerial performance based on

A. B. C. D.

A single ultimate measure of operating results, such as residual income. Multiple financial and nonfinancial measures. Multiple nonfinancial measures only. Multiple financial measures only. Answer (A) is incorrect because the balanced scorecard approach uses multiple measures. Answer (B) is correct. The trend in managerial performance evaluation is the balanced scorecard approach. Multiple measures of performance permit a determination as to whether a manager is achieving certain objectives at the expense of others that may be equally or more important. These measures may be financial or nonfinancial and usually include items in four categories: (1) financial; (2) customer; (3) internal business processes; and (4) learning, growth, and innovation. Answer (C) is incorrect because the balanced scorecard approach includes financial measures. Answer (D) is incorrect because the balanced scorecard approach includes nonfinancial measures.

[38] Gleim #: 1.38 -- Source: Publisher On a balanced scorecard, which of the following is not a customer measure?

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A. B. C. D.

Market share. Economic value added. Service response time. Warranty expense. Answer (A) is incorrect because market share and its trend is a customer measure. Answer (B) is correct. Customer measures include market share and its trend, service response time, delivery performance, warranty returns, expense, complaints, and survey results. Economic value added, or EVA, is a financial measure. Answer (C) is incorrect because service response time is a customer measure. Answer (D) is incorrect because warranty expense is a customer measure.

[39] Gleim #: 1.39 -- Source: CPA, adapted Under the balanced scorecard concept, employee satisfaction and retention are measures used under which of the following perspectives?

A. B. C. D.

Customer. Internal business. Learning and growth. Financial. Answer (A) is incorrect because, for the customer perspective, the CSFs may be customer satisfaction and retention rate, dealer and distributor relationships, marketing and selling performance, prompt delivery, and quality. Answer (B) is incorrect because, for the internal business perspective, the CSFs may be quality, productivity, flexibility of response to changing conditions, operating readiness, and safety. Answer (C) is correct. The balanced scorecard is an accounting report that connects the firms critical success factors (CSFs) determined in a strategic analysis to measures of its performance. CSFs are financial and nonfinancial measures. For the learning, growth, and innovation perspective, the CSFs may be development of new products, promptness of their introduction, human resource development, morale, and competence of the workforce. Measures of employee satisfaction, retention, and competence may include R&D personnel qualifications, hours of training, skill set levels attained, personnel turnover, and personnel complaints and survey results. Answer (D) is incorrect because, for the financial perspective, the CSFs may be sales, fair value of the firms stock, profits, and liquidity.

[40] Gleim #: 1.40 -- Source: Publisher On a balanced scorecard, which is more of an internal process measure than an external-based measure?

A. B. C. D.

Cycle time. Profitability. Customer satisfaction. Market share. Answer (A) is correct. Cycle time is the manufacturing time to complete an order. Thus, cycle time is strictly related to internal processes. Profitability is a combination of internal and external considerations. Customer satisfaction and market share are related to how customers perceive a product and how competitors react. Answer (B) is incorrect because profitability is a measure that includes external considerations. Answer (C) is incorrect because customer satisfaction is a measure that includes external considerations. Answer (D) is incorrect because market share is a measure that includes external considerations.

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[41] Gleim #: 1.41 -- Source: Publisher According to ISO 9000 standards, which of the following is false in regard to registrars?

A. B. C. D.

Most employees are subject to being audited. Companies may have preliminary audits by registrars. Employees must be able to competently describe their jobs and demonstrate that they are performing properly. Upon satisfactory completion of an on-site visit, a registrar may issue a certificate describing the scope of the registration, which is valid for 3 years. Answer (A) is correct. During an on-site visit, the registrar has the right to audit all employees if he or she decides to do so. Employees must have the ability to explain their jobs and show that they are capable of performing properly. Answer (B) is incorrect because some companies have preliminary audits by registrars to prepare for the official audit. Answer (C) is incorrect because employees must be able to say what they do and demonstrate that they do what they say. Answer (D) is incorrect because a registrar who is convinced that a quality system conforms to the selected standard issues a certificate describing the scope of the registration. The registration is usually valid for a 3-year period.

[42] Gleim #: 1.42 -- Source: Publisher Which of the following is not true about the advantages of adopting ISO 9000 standards?

A. B. C. D.

Adoption of ISO 9000 standards may allow the company to sell products in foreign markets. ISO registration makes customers more comfortable with the suppliers products and services. ISO 9000 allows companies to understand who internal customers and users are without sharing private information. ISO registration may help companies discover internal process and quality improvements. Answer (A) is incorrect because many foreign countries are beginning to require adoption of ISO 9000 standards as a prerequisite for a company to sell products or services in that country. Answer (B) is incorrect because many companies view ISO registration as a key to remaining competitive. ISO registration allows customers to be more comfortable with suppliers products and services. Answer (C) is correct. Market pressure is usually the main driving force for companies that adopt ISO 9000 standards. However, many of the companies that register uncover internal process and quality improvement as a result. ISO 9000 forces companies to share information, which leads to a better understanding of who internal customers and users are. Answer (D) is incorrect because many companies that implement ISO 9000 standards uncover internal process and quality improvements.

[43] Gleim #: 1.43 -- Source: Publisher Why have many European Union countries not adopted ISO 14000 standards?

A. B. C. D.

Adhering to ISO 14000 standards will not reduce monitoring and inspection by regulatory agencies. Individual European Union countries standards are typically more strict than ISO 14000 standards. Regulators are permitted to use voluntary audits as a basis for punitive action. ISO 14000 standards will not make it easier to do business across borders.

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Answer (A) is incorrect because many believe adhering to ISO 14000 standards will reduce monitoring or inspection by regulatory agencies. Answer (B) is correct. Many European countries already have environmental systems in place, and many individual countries standards are typically more strict than the ISO 14000 standards. Answer (C) is incorrect because many countries in the European Union have adopted measures similar to the ones in the US to prevent self-incrimination during voluntary ISO audits. Answer (D) is incorrect because ISO 14000 establishes internationally recognized standards that are intended to diminish trade barriers and make it easier to do business across borders. [44] Gleim #: 1.44 -- Source: Publisher Which of the following is not required when ISO 9000 standards are adopted?

A. B. C. D.

Organization of a quality management system. Creation of an internal audit system. Consistent high quality products. On-site inspections by a registrar. Answer (A) is incorrect because one of the most important steps to adhering to ISO 9000 standards is to organize a QMS. A QMS explains the companys quality control and managements commitment to quality. Answer (B) is incorrect because internal audits assure that the company is complying with the documented QMS procedures and ISO 9000 standards. Answer (C) is correct. ISO 9000 is a set of generic standards for establishing and maintaining a quality system within a company. The standards provide no basis for judging the quality of the end product. The marketplace will make this determination on its own. The objective of ISO 9000 standards is to ensure consistent quality. Answer (D) is incorrect because a registrar must ensure that the companys quality control system conforms to the selected standard.

[45] Gleim #: 1.45 -- Source: CIA 1196 III-60 The International Organization for Standardization has developed standards for ring networks that include fault management, configuration management, accounting management, security management, and performance monitoring. Which of the following controls is included in the performance-monitoring standards?

A. B. C. D.

Reporting the failure of network fiber-optic lines. Recording unauthorized access violations. Compiling statistics on the number of times that application software is used. Allocating network costs to system users of the network. Answer (A) is incorrect because the failure of network fiber-optic lines is a fault management control. Answer (B) is incorrect because recording unauthorized access violations is a security management control. Answer (C) is correct. The IOS consists of standards organizations from more than 75 countries. Its performancemonitoring standards pertain to managements ongoing assessment of the quality of performance over time. Recording software usage is a performance-monitoring control concerned with the extent and efficiency of network software use. Answer (D) is incorrect because allocating network costs to system users of the network is an accounting management control.

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[46] Gleim #: 1.46 -- Source: CIA 593 III-64 What coefficient of correlation results from the following data?

X 1 2 3 4 5

Y 10 8 6 4 2

A. B. C. D.

0 1 +1 Cannot be determined from the data given. Answer (A) is incorrect because a perfect negative correlation exists. Answer (B) is correct. The coefficient of correlation (in standard notation, r) measures the strength of the linear relationship. The magnitude of r is independent of the scales of measurement of X and Y. Its range is 1.0 to 1.0. A value of 1.0 indicates a perfectly inverse linear relationship between X and Y. A value of zero indicates no linear relationship between X and Y. A value of +1.0 indicates a perfectly direct relationship between X and Y. As X increases by 1, Y consistently decreases by 2. Hence, a perfectly inverse relationship exists, and r must be equal to 1.0. Answer (C) is incorrect because an inverse, not a direct, relationship exists. Answer (D) is incorrect because a linear relationship exists between X and Y.

[47] Gleim #: 1.47 -- Source: CIA 1194 II-46 In regression analysis, which of the following correlation coefficients represents the strongest relationship between the independent and dependent variables?

A. B. C. D.

1.03 .02 .89 .75 Answer (A) is incorrect because 1.03 is an impossible value. Answer (B) is incorrect because .02 is a very weak correlation coefficient. Answer (C) is correct. Because the range of values is between 1.0 and 1.0, .89 suggests a very strong inverse relationship between the independent and dependent variables. A value of 1.0 signifies a perfect inverse relationship, and a value of 1.0 signifies a perfect direct relationship. Answer (D) is incorrect because .75 is .25 from the maximum value, whereas .89 is .11 from the minimum value.

[48] Gleim #: 1.48 -- Source: CIA 595 II-46 The internal auditor of a bank has developed a multiple regression model which has been used for a number of years to estimate the amount of interest income from commercial loans. During the current year, the auditor applies the model and discovers that the r2 value has decreased dramatically, but the model otherwise seems to be working okay. Which of the following conclusions are justified by the change?

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A. B. C. D.

Changing to a cross-sectional regression analysis should cause r 2 to increase. Regression analysis is no longer an appropriate technique to estimate interest income. Some new factors, not included in the model, are causing interest income to change. A linear regression analysis would increase the models reliability. Answer (A) is incorrect because cross-sectional regression analysis is inappropriate. The auditor is trying to estimate changes in a single account balance over time. Answer (B) is incorrect because regression analysis may still be the most appropriate methodology to estimate interest income, but the auditor should first understand the factors that may be causing r 2 to decrease. The reason may be a systematic error in the account balance. Answer (C) is correct. The coefficient of determination (r 2) is the amount of variation in the dependent variable (interest income) that is explained by the independent variables. In this case, less of the change in interest income is explained by the model. Thus, some other factor must be causing interest income to change. This change merits audit investigation. Answer (D) is incorrect because linear regression models are simpler models, but the auditor should be searching for a systematic error in the account balance or applying a more complex model.

[Fact Pattern #4]

In preparing the annual profit plan for the coming year, Wilkens Company wants to determine the cost behavior pattern of the maintenance costs. Wilkens has decided to use linear regression by employing the equation y = a + bx for maintenance costs. The prior years data regarding maintenance hours and costs, and the results of the regression analysis, are given below and in the opposite column. Average cost per hour a b Standard error of a Standard error of b Standard error of the estimate r2 $9.00 684.65 7.2884 49.515 .12126 34.469 .99724

Hours of Activity January February March April May June July August September October November December Sum Average 480 320 400 300 500 310 320 520 490 470 350 340 4,800 400

Maintenance Costs $ 4,200 3,000 3,600 2,820 4,350 2,960 3,030 4,470 4,260 4,050 3,300 3,160 $43,200 $ 3,600

[49] Gleim #: 1.49 -- Source: CMA 1290 4-27 (Refers to Fact Pattern #4) In the standard regression equation y = a + bx, the letter b is best described as a(n)

A. B. C. D.

Independent variable. Dependent variable. Constant coefficient. Variable coefficient.

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Answer (A) is incorrect because x is the independent variable. Answer (B) is incorrect because the dependent variable is y. Answer (C) is incorrect because the constant coefficient is a. Answer (D) is correct. In the standard regression equation, b represents the variable coefficient. For example, in a cost determination regression, y equals total costs, b is the variable cost per unit, x is the number of units produced, and a is fixed cost. [50] Gleim #: 1.50 -- Source: CMA 1290 4-28 (Refers to Fact Pattern #4) The letter x in the standard regression equation is best described as a(n)

A. B. C. D.

Independent variable. Dependent variable. Constant coefficient. Coefficient of determination. Answer (A) is correct. The letter x in the standard regression equation is the independent variable. For example, in a regression to determine the total cost of production, x equals units produced. Answer (B) is incorrect because the dependent variable is y. Answer (C) is incorrect because the constant coefficient is a. Answer (D) is incorrect because r 2 is the coefficient of determination.

[51] Gleim #: 1.51 -- Source: CMA 1290 4-29 (Refers to Fact Pattern #4) Based upon the data derived from the regression analysis, 420 maintenance hours in a month would mean the maintenance costs (rounded to the nearest dollar) would be budgeted at

A. B. C. D.

$3,780 $3,600 $3,790 $3,746 Answer (A) is incorrect because the budgeted maintenance costs are $3,746. Answer (B) is incorrect because the budgeted maintenance costs are $3,746. Answer (C) is incorrect because the budgeted maintenance costs are $3,746. Answer (D) is correct. Substituting the given data into the regression equation results in a budgeted cost of $3,746 (rounded to the nearest dollar).

y = a + bx y = 684.65 + 7.2884(420) y = $3,746

[52] Gleim #: 1.52 -- Source: CMA 1290 4-30 (Refers to Fact Pattern #4) The percentage of the total variance that can be explained by the regression equation is

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A. B. C. D.

99.724% 69.613% 80.982% 99.862% Answer (A) is correct. The coefficient of determination (r) measures the percentage of the total variance in cost that can be explained by the regression equation. If the coefficient of determination is .99724, 99.724% of the variance is explained by the regression equation. Thus, the values in the regression equation explain virtually the entire amount of total cost. Answer (B) is incorrect because the percentage of the total variance explained by the regression equation is 99.724%, which corresponds to the coefficient of determination (r), or .99724. Answer (C) is incorrect because the percentage of the total variance explained by the regression equation is 99.724%, which corresponds to the coefficient of determination (r), or .99724. Answer (D) is incorrect because the percentage of the total variance explained by the regression equation is 99.724%, which corresponds to the coefficient of determination (r), or .99724.

[53] Gleim #: 1.53 -- Source: CIA 1195 II-30 A division uses a regression in which monthly advertising expenditures are used to predict monthly product sales (both in millions of dollars). The results show a regression coefficient for the independent variable equal to 0.8. This coefficient value indicates that

A. B. C. D.

The average monthly advertising expenditure in the sample is $800,000. When monthly advertising is at its average level, product sales will be $800,000. On average, every additional dollar of advertising results in $.80 of additional sales. Advertising is not a good predictor of sales because the coefficient is so small. Answer (A) is incorrect because a regression coefficient is unrelated to the means of the variables. Answer (B) is incorrect because, to predict a specific value of sales, the value of the independent variable is multiplied by the coefficient. The product is then added to the y-intercept value. Answer (C) is correct. The regression coefficient represents the change in the dependent variable corresponding to a unit change in the independent variable. Thus, it is the slope of the regression line. Answer (D) is incorrect because the absolute size of the coefficient bears no necessary relationship to the importance of the variable.

[54] Gleim #: 1.54 -- Source: CIA 595 II-47 An internal auditor for a large automotive parts retailer wishes to perform a risk analysis and wants to use an appropriate statistical tool to help identify stores that would be out of line compared to the majority of stores. The most appropriate statistical tool to use is

A. B. C. D.

Linear time series analysis. Cross-sectional regression analysis. Cross tabulations with chi-square analysis of significance. Time series multiple regression analysis to identify changes in individual stores over time.

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Answer (A) is incorrect because linear time series analysis is inapplicable. It is a simple model that compares data for an individual store over time. Answer (B) is correct. Time series data pertain to a given entity over a number of prior time periods. Cross-sectional data, however, pertain to different entities for a given time period or at a given time. Thus, cross-sectional regression analysis is the most appropriate statistical tool because it compares attributes of all stores operating statistics at one moment in time. Answer (C) is incorrect because cross tabulations have to be built on a model of expectations. Unless the model is built, the analysis is not useful. Answer (D) is incorrect because the objective is to compare stores at one moment in time. Multiple regression time series analysis compares the performance of an individual store over a period of time. [55] Gleim #: 1.55 -- Source: CIA 1195 III-11 Quality control programs employ many tools for problem definition and analysis. A scatter diagram is one of these tools. The objective of a scatter diagram is to

A. B. C. D.

Display a population of items for analysis. Show frequency distribution in graphic form. Divide a universe of data into homogeneous groups. Show the vital trend and separate trivial items. Answer (A) is correct. The objective of a scatter diagram is to demonstrate correlations. Each observation is represented by a dot on a graph corresponding to a particular value of X (the independent variable) and Y (the dependent variable). Answer (B) is incorrect because the objective of a histogram is to show frequency distribution in graphic form. Answer (C) is incorrect because the objective of stratification is to divide a universe of data into homogeneous groups. Answer (D) is incorrect because regression analysis is used to find trend lines.

[56] Gleim #: 1.56 -- Source: Publisher Violation of which assumption underlying regression analysis is prevalent in time series analysis?

A. B. C. D.

Variance of error term is constant. Error terms are independent. Distribution of error terms is normal. Expected value of error term equals zero. Answer (A) is incorrect because constant variance of the error term is usually met. Answer (B) is correct. Time series analysis is a regression model in which the independent variable is time. In time series analysis, the value of the next time period is frequently dependent on the value of the time period before that. Hence, the error terms are usually correlated or dependent on the prior period; i.e., they are characterized by autocorrelation (serial correlation). Answer (C) is incorrect because normal distribution of the error term is usually met. Answer (D) is incorrect because an expected value of the error term equal to zero is usually met.

[57] Gleim #: 1.57 -- Source: CIA 589 III-50 The moving-average method of forecasting

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A. B. C. D.

Is a cross-sectional forecasting method. Regresses the variable of interest on a related variable to develop a forecast. Derives final forecasts by adjusting the initial forecast based on the smoothing constant. Includes each new observation in the average as it becomes available and discards the oldest observation. Answer (A) is incorrect because cross-sectional regression analysis examines relationships among large amounts of data (e.g., many or different production methods or locations) at a particular moment in time. Answer (B) is incorrect because regression analysis relates the forecast to changes in particular variables. Answer (C) is incorrect because, under exponential smoothing, each forecast equals the sum of the last observation times the smoothing constant, plus the last forecast times one minus the constant. Answer (D) is correct. The simple moving-average method is a smoothing technique that uses the experience of the past N periods (through time period t) to forecast a value for the next period. Thus, the average includes each new observation and discards the oldest observation. The forecast formula for the next period (for time period t+1) is the sum of the last N observations divided by N.

[58] Gleim #: 1.58 -- Source: CIA 594 II-38 As part of a risk analysis, an auditor wishes to forecast the percentage growth in next months sales for a particular plant using the past 30 months sales results. Significant changes in the organization affecting sales volumes were made within the last 9 months. The most effective analysis technique to use would be

A. B. C. D.

Unweighted moving average. Exponential smoothing. Queuing theory. Linear regression analysis. Answer (A) is incorrect because an unweighted average will not give more importance to more recent data. Answer (B) is correct. Under exponential smoothing, each forecast equals the sum of the last observation times the smoothing constant, plus the last forecast times one minus the constant. Thus, exponential means that greater weight is placed on the most recent data, with the weights of all data falling off exponentially as the data age. This feature is important because of the organizational changes that affected sales volume. Answer (C) is incorrect because queuing theory is used to minimize the cost of waiting lines. Answer (D) is incorrect because linear regression analysis determines the equation for the relationship among variables. It does not give more importance to more recent data.

[59] Gleim #: 1.59 -- Source: CMA 1293 4-24 The average labor cost per unit for the first batch produced by a new process is $120. The cumulative average labor cost after the second batch is $72 per product. Using a batch size of 100 and assuming the learning curve continues, the total labor cost of four batches will be

A. B. C. D.

$4,320 $10,368 $2,592 $17,280

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Answer (A) is incorrect because $4,320 equals the cost of the items in the fourth batch. Answer (B) is incorrect because $10,368 is based on the assumption that the cumulative average unit labor cost is reduced by the learning curve percentage with each batch, not each doubling of output. Answer (C) is incorrect because $2,592 represents the labor cost of 100 units at the unit rate expected after another doubling of production to eight batches. Answer (D) is correct. The learning curve reflects the increased rate at which people perform tasks as they gain experience. The time required to perform a given task becomes progressively shorter. Ordinarily, the curve is expressed in a percentage of reduced time to complete a task for each doubling of cumulative production. One common assumption in a learning curve model is that the cumulative average time (and labor cost) per unit is reduced by a certain percentage each time production doubles. Given a $120 cost per unit for the first 100 units and a $72 cost per unit when cumulative production doubled to 200 units, the learning curve percentage must be 60% ($72 $120). If production is again doubled to 400 units (four batches), the average unit labor cost should be $43.20 ($72 60%). Hence, total labor cost for 400 units is estimated to be $17,280 (400 $43.20). [Fact Pattern #5]

Moss Point Manufacturing recently completed and sold an order of 50 units that had costs as shown in the next column. The company has now been requested to prepare a bid for 150 units of the same product.

Direct materials Direct labor ($8.50 1,000 hours) Variable overhead ($4.00 1,000 hours)* Fixed overhead **

$ 1,500 8,500 4,000 1,400 $15,400

* Applied on the basis of direct labor hours ** Applied at the rate of 10% of variable cost

[60] Gleim #: 1.60 -- Source: CMA 1288 5-19 (Refers to Fact Pattern #5) If an 80% learning curve is applicable, Moss Points total cost on this order would be estimated at

A. B. C. D.

$26,400 $32,000 $38,000 $41,800

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Answer (A) is correct. Assuming that the cumulative average-time model applies, an 80% learning curve means that the cumulative average time per unit (and labor cost, given a constant labor rate) declines by 20% when unit output doubles in the early stages of production. The first lot size was 50 units, which was produced at a total cost of $15,400 ($1,500 for materials and $13,900 for labor and overhead). Materials costs are strictly variable and should remain proportional to production. The labor ($8,500) and variable overhead ($4,000) costs (labor-related), however, will be affected by the learning curve. The average cost per lot for labor and variable overhead after 100 units have been produced should be 80% of the costs of the first lot of 50 units. Thus, the average labor and variable overhead cost per 50-unit lot will be $10,000 ($12,500 80%). If production doubles again (to a total production of 200 units or four lots of 50 each), the cumulative average cost for labor and variable overhead will be $8,000 per lot ($10,000 80%). Given four lots of 50 each, at an average cost of $8,000 per lot, the total cost for labor and variable overhead must be $32,000. Adding $6,000 for raw materials ($1,500 per 50-unit lot) gives a total variable cost of $38,000 for 200 units. Fixed overhead is 10% of total variable cost, so total cost is $41,800. The total cost for the last 150 units is $26,400 ($41,800 $15,400). Answer (B) is incorrect because $32,000 is the total cost for labor and variable overhead for 200 units. Answer (C) is incorrect because $38,000 is the total variable cost for 200 units. Answer (D) is incorrect because $41,800 is the total cost for 200 units. [61] Gleim #: 1.61 -- Source: CMA 1288 5-20 (Refers to Fact Pattern #5) If Moss Point had experienced a 70% learning curve, the bid for the 150 units would

A. B. C. D.

Show a 30% reduction in the total direct labor hours required with no learning curve. Include increased fixed overhead costs. Be 10% lower than the total bid at an 80% learning curve. Include 6.40 direct labor hours per unit at $8.50 per hour. Answer (A) is incorrect because, with no learning curve effect, estimated total hours would be 4,000 instead of 1,960, a change of more than 50%. Answer (B) is incorrect because fixed costs applied per lot would decline because they are based on labor hours, which are declining. Answer (C) is incorrect because, with no learning curve effect, estimated total hours would be 4,000 instead of 1,960, a change of more than 50%. Answer (D) is correct. The sum of the direct labor hours for the initial lot of 50 units was 1,000. A second lot of 50 would reduce the cumulative hours per lot to 700 (70% 1,000). A doubling to four lots would reduce the cumulative hours per lot to 490 (70% 700). Thus, for an output of 200 units, the total hours worked would be 1,960 (4 490). Subtracting the 1,000 hours required for the first 50 units from the 1,960-hour total gives 960 hours for the last 150 units. Dividing 960 hours by 150 units produces a per-unit time of 6.4 hours.

[62] Gleim #: 1.62 -- Source: CMA 683 5-8 A company is simulating the actions of a government agency in which 50% of the time a recall of a product is required, 40% of the time only notification of the buyer about a potential defect is required, and 10% of the time no action on its part is required. Random numbers of 1 to 100 are being used. An appropriate assignment of random numbers for the recall category would be

A. B. C. D.

1-40 40-90 61-100 11-60

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Answer (A) is incorrect because 1-40 is an appropriate assignment of random numbers for the notification category. Answer (B) is incorrect because 40-90 includes 51 numbers. Answer (C) is incorrect because 61-100 is an appropriate assignment of random numbers for the notification category. Answer (D) is correct. Given a 50% chance of a recall, 50 different numbers should be assigned to that alternative. This answer is the only alternative with 50 numbers (11-60). [63] Gleim #: 1.63 -- Source: CMA 1294 4-29 Quick Response Plumbing (QRP), a wholesale distributor, supplies plumbing contractors and retailers throughout the Northeast on a next-day delivery basis. QRP has a centrally located warehouse to accept receipts of plumbing supplies. The warehouse has a single dock to accept and unload railroad freight cars during the night. It takes 5 hours to unload each freight car. QRPs prior records indicate that the number of freight cars that arrive in the course of a night range from zero to five or more, with no indicated pattern of arrivals. If more than two freight cars arrive on the same night, some freight must be held until the next day for unloading. QRP wants to estimate the wait time when more than two freight cars arrive in the same night. The appropriate technique to analyze the arrival of freight cars is

A. B. C. D.

Integer programming. Linear programming. Monte Carlo simulation. Regression analysis. Answer (A) is incorrect because integer programming is a variation of linear programming that concerns problems in which some variables are not continuous. Integer programming problems are also known as discrete models because the variables take on discrete, noncontinuous values. Answer (B) is incorrect because linear programming is a technique used to maximize a revenue or profit function, or minimize a cost function, subject to constraints such as limited resources or minimum (or maximum) levels of production time. Answer (C) is correct. The Monte Carlo simulation method is often used to generate the individual values for a random variable. The performance of a quantitative model under uncertainty may be investigated by randomly selecting values for each variable in the model (based on the probability distribution of each variable) and then calculating the value of the solution. If this process is performed many times, the distribution of results from the model will be obtained. Answer (D) is incorrect because regression analysis is used to find an equation for the linear relationships among variables.

[64] Gleim #: 1.64 -- Source: CMA 690 5-21 Through the use of decision models, managers thoroughly analyze many alternatives and decide on the best alternative for the company. Often the actual results achieved from a particular decision are not what was expected when the decision was made. In addition, an alternative that was not selected would have actually been the best decision for the company. The appropriate technique to analyze the alternatives by using expected inputs and altering them before a decision is made is

A. B. C. D.

Expected value analysis. Linear programming. Program Evaluation Review Technique (PERT). Sensitivity analysis.

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Answer (A) is incorrect because expected value analysis is used to determine an anticipated return or cost based upon probabilities of events and their related outcomes. Answer (B) is incorrect because linear programming optimizes a function given certain constraints. Answer (C) is incorrect because PERT is a network technique used to plan and control large projects. Answer (D) is correct. Sensitivity modeling can be used to determine the outcome of a variety of decisions. A trial-and-error method may be adopted, usually in a computer model, to calculate the sensitivity of the solution (variability of outcomes) to changes in a variable. [65] Gleim #: 1.65 -- Source: CIA 1190 III-46 A firm is attempting to estimate the reserves for doubtful accounts. The probabilities of these doubtful accounts follow a transition process over time. They evolve from their starting value to a changed value. As such, the most effective technique to analyze the problem is

A. B. C. D.

Markov chain analysis. Econometric theory. Monte Carlo analysis. Dynamic programming. Answer (A) is correct. A Markov chain is a series of events in which the probability of an event depends on the immediately preceding event. An example is the game of blackjack in which the probability of certain cards being dealt is dependent upon what cards have already been dealt. In the analysis of bad debts, preceding events, such as collections, credit policy changes, and writeoffs, affect the probabilities of future losses. Answer (B) is incorrect because econometrics forecasts the impact of different economic policies and conditions. Answer (C) is incorrect because Monte Carlo analysis is a simulation technique that uses random-number procedures to create values for probabilistic components. Answer (D) is incorrect because dynamic programming is a problem-solving approach that breaks a large mathematical model into a number of smaller, manageable problems.

[66] Gleim #: 1.66 -- Source: CIA 1193 III-67 A company has several departments that conduct technical studies and prepare reports for clients. Recently, there have been long delays in having these reports copied at the companys centralized copy center because of the dramatic increase in business. Management is considering decentralizing copy services to reduce the turnaround and provide clients with timely reports. An appropriate technique for minimizing turnaround time and the cost of providing copy services is

A. B. C. D.

Queuing theory. Linear programming. Regression analysis. Game theory. Answer (A) is correct. Queuing theory is a group of mathematical models for systems involving waiting lines. In general, a queuing system consists of a waiting line and a service facility (a copy center in this case). The objective is to minimize total costs, including both service and waiting costs (turnaround time), for a given rate of arrivals. Answer (B) is incorrect because linear programming optimizes a given objective function subject to constraints. Answer (C) is incorrect because regression analysis estimates the relation among variables. Answer (D) is incorrect because game theory is an approach to decision making that considers the actions of competitors.

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[67] Gleim #: 1.67 -- Source: CMA 688 5-27 Queuing models are concerned with balancing the cost of waiting in the queue with the

A. B. C. D.

Cost of providing service. Number of customers in the queue. Average waiting time in the queue. Usage rate for the service being rendered. Answer (A) is correct. Queuing (waiting-line) models minimize, for a given rate of arrivals, the sum of (1) the cost of providing service (including facility costs and operating costs) and (2) the cost of idle resources waiting in line. The latter may be a direct cost, if paid employees are waiting, or an opportunity cost in the case of waiting customers. This minimization occurs at the point where the cost of waiting is balanced by the cost of providing service. Answer (B) is incorrect because queuing theory minimizes the sum of the costs of waiting and of providing service. Answer (C) is incorrect because queuing theory minimizes the sum of the costs of waiting and of providing service. Answer (D) is incorrect because queuing theory minimizes the sum of the costs of waiting and of providing service.

[68] Gleim #: 1.68 -- Source: CMA 688 5-28 The operating condition that cannot be identified by using a queuing model is the

A. B. C. D.

Average percentage of time that a service facility is idle. Probability of a specified number of units in the queue. Actual amount of time each unit spends in the queue. Average number of units in the system and the mean length of the queue. Answer (A) is incorrect because the queuing model calculates the average percentage of time that a service facility is idle, the probability of a specified number of units in the queue, and the average number of units in the system and the mean length of the queue. Answer (B) is incorrect because the queuing model calculates the average percentage of time that a service facility is idle, the probability of a specified number of units in the queue, and the average number of units in the system and the mean length of the queue. Answer (C) is correct. Queuing models determine the operating characteristics of a waiting line: the probability that no units are in the system, the average units in the line, the average units in the system, the average time a unit waits, the average time a unit is in the system, the probability that a unit must wait, and the probability of a given number of units in the system. However, the actual time spent in the queue cannot be determined from the model. Answer (D) is incorrect because the queuing model calculates the average percentage of time that a service facility is idle, the probability of a specified number of units in the queue, and the average number of units in the system and the mean length of the queue.

[69] Gleim #: 1.69 -- Source: CIA 586 III-15 A bank has changed from a system in which lines are formed in front of each teller to a one-line, multiple-server system. When a teller is free, the person at the head of the line goes to that teller. Implementing the new system will

A. B. C. D.

Decrease the banks wage expenses because the new system uses fewer tellers. Decrease time customers spend in the line. Increase accuracy in teller reconciliations at the end of the day because fewer customers are served by each teller. Improve on-the-job training for tellers because each will perform different duties.

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Answer (A) is incorrect because the number of employees is unlikely to change due to the new system. Answer (B) is correct. When all customers must wait in a single queue, a decrease in waiting time is possible given multiple servers. An added effect is to increase customer satisfaction. Answer (C) is incorrect because, assuming a Poisson process, the number of customers per teller will not change. Answer (D) is incorrect because tellers duties will not change, so on-the-job training will not improve. [70] Gleim #: 1.70 -- Source: CIA 1187 III-39 The drive-through service at a fast-food restaurant consists of driving up to place an order, advancing to a window to pay for the order, and then advancing to another window to receive the items ordered. This type of waiting-line system is

A. B. C. D.

Single channel, single phase. Single channel, multiple phase. Multiple channel, single phase. Multiple channel, multiple phase. Answer (A) is incorrect because service by one ticket-seller at a movie theater is an example of a single-channel, singlephase system. Answer (B) is correct. The drive-through represents a single queue (channel). Because this waiting line has three services in series, it may be said to be multiple phase. Another example is the typical factory assembly line. This terminology (channel, phase), however, is not used by all writers on queuing theory. Answer (C) is incorrect because supermarket checkout lines are a common example of multiple single-phase servers servicing multiple lines. Answer (D) is incorrect because an example of a multiple-channel, multiple-phase system is a set of supermarket checkout lines each of which is served in sequence by a cashier and a person who packs grocery bags.

[71] Gleim #: 1.71 -- Source: CIA 584 IV-34 A post office serves customers in a single line at one service window. During peak periods, the rate of arrivals has a Poisson distribution with an average of 100 customers per hour and service times that are exponentially distributed with an average of 60 seconds per customer. From this, one can conclude that the

A. B. C. D.

Queue will expand to infinity. Server will be idle one-sixth of the time. Average rate is 100 customers per hour. Average customer waiting time is 2.5 minutes. Answer (A) is correct. One hundred customers arrive in line per hour and only 60 are serviced per hour. Accordingly, the queue will expand to infinity during peak periods. Answer (B) is incorrect because insufficient information is given to determine overall idle time or average customer waiting time. The question gives only peak period data. Answer (C) is incorrect because peak customer service is only 60 per hour. Answer (D) is incorrect because insufficient information is given to determine overall idle time or average customer waiting time. The question gives only peak period data.

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[Fact Pattern #6]

A bank has two drive-in lanes to serve customers, one attached to the bank itself, the second on an island. One teller serves both stations. The bank is interested in determining the average waiting times of customers and has developed a model based on random numbers. The two key factors are the time between successive car arrivals and the time customers wait in line. Assume that the analysis begins with cars just arriving at both service windows, both requiring 3 minutes of service time. Car 1 is at the attached window and car 2 at the island window. A car will always go to the window attached to the bank unless that window has more cars waiting than the island window. The lone teller will always serve the car that arrived first. If two cars arrive simultaneously, the one at the attached window will be served before the one at the island.

Based on a known probability distribution, the bank assigns random numbers to arrival and service times: Time between Arrivals 1 minute 2 minutes 3 minutes 4 minutes

Random # 1 2, 3 4, 5, 6 7, 8

Random # 1, 2 3 4, 5, 6 7, 8, 9

Service Time 1 minute 2 minutes 3 minutes 4 minutes

The bank then selects random numbers for the next two cars as Random Numbers Selected: Arrival Car 3 Car 4 #3 #7 Service #7 #8

[72] Gleim #: 1.72 -- Source: CIA 1192 III-98 (Refers to Fact Pattern #6) The arrival time follows which probability distribution?

A. B. C. D.

Binomial. Chi-square. Poisson. Exponential. Answer (A) is incorrect because the binomial distribution is a discrete distribution in which each trial has just two outcomes. Answer (B) is incorrect because the chi-square distribution is a continuous distribution used to measure the fit between actual data and the theoretical distribution. Answer (C) is correct. Queuing models assume that arrivals follow a Poisson process: the events (arrivals) are independent, any number of events must be possible in the interval of time, the probability of an event is proportional to the length of the interval, and the probability of more than one event is negligible if the interval is sufficiently small. If is the average number of events in a given interval, k is the number of events, and e is the natural logarithm (2.71828...), the probability of k is

ke- f(k) = k! Answer (D) is incorrect because service time has an exponential distribution. This distribution gives the probability of zero events in a given interval, i.e., the probability of a specified time between arrivals. [73] Gleim #: 1.73 -- Source: CIA 1192 III-99 (Refers to Fact Pattern #6) The time that car 3 will have to wait to be serviced (not including its own service time) is

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A. B. C. D.

0-2 minutes. 3 minutes. 4 minutes. 5+ minutes. Answer (A) is incorrect because car 3 must wait for 4 minutes. Answer (B) is incorrect because car 3 must wait for 4 minutes. Answer (C) is correct. Car 1 is at the attached window and will require 3 minutes to service. Car 2 must wait for car 1 to be serviced (3 minutes in the queue + 3 minutes to be serviced = 6 minutes). Car 3 arrived at the attached window 2 minutes after cars 1 and 2. It must wait 1 minute for car 1 to be serviced and 3 minutes for car 2 to be serviced, a waiting time of 4 minutes. Answer (D) is incorrect because car 3 must wait for 4 minutes.

[74] Gleim #: 1.74 -- Source: CIA 1192 III-100 (Refers to Fact Pattern #6) The time that car 4 will have to wait to be serviced (not including its own service time) is

A. B. C. D.

0-2 minutes. 3 minutes. 4 minutes. 5+ minutes. Answer (A) is incorrect because car 4 must wait 4 minutes. Answer (B) is incorrect because car 4 must wait 4 minutes. Answer (C) is correct. Car 4 arrives at the just-vacated island window 4 minutes after car 3. It must wait 4 minutes for car 3 to be serviced. Answer (D) is incorrect because car 4 must wait 4 minutes.

[Fact Pattern #7] An organization has collected data on the complaints made by personal computer users and has categorized the complaints.

(Refer to Figure FIGURE18_12.) [75] Gleim #: 1.75 -- Source: CIA 1195 III-15 (Refers to Fact Pattern #7) Using the information collected, the organization should focus on

A. B. C. D.

The total number of personal computer complaints that occurred. The number of computer complaints associated with diskette problems and new software usage. The number of computer complaints associated with the lack of user knowledge and hardware problems. The cost to alleviate all computer complaints.

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Answer (A) is incorrect because more detailed information is not available. The Pareto diagram does not focus on the total quantity of computer complaints. Answer (B) is incorrect because complaints about diskettes and software are infrequent. Answer (C) is correct. Complaints based on lack of user knowledge and hardware problems are by far the most frequent according to this chart. Consequently, the company should devote its resources primarily to these issues. Answer (D) is incorrect because cost information is not provided. [76] Gleim #: 1.76 -- Source: CIA 1195 III-16 (Refers to Fact Pattern #7) The chart displays

A. B. C. D.

The arithmetic mean of each computer complaint. The relative frequency of each computer complaint. The median of each computer complaint. The absolute frequency of each computer complaint. Answer (A) is incorrect because the chart does not display arithmetic means, relative frequencies, or medians of each type of complaint. Answer (B) is incorrect because the chart does not display arithmetic means, relative frequencies, or medians of each type of complaint. Answer (C) is incorrect because the chart does not display arithmetic means, relative frequencies, or medians of each type of complaint. Answer (D) is correct. This Pareto diagram depicts the frequencies of complaints in absolute terms. It displays the actual number of each type of complaint. The chart does not display arithmetic means, relative frequencies, or medians of each type of complaint.

[77] Gleim #: 1.77 -- Source: CMA 689 5-25 A Gantt chart

A. B. C. D.

Shows the critical path for a project. Is used for determining an optimal product mix. Shows only the activities along the critical path of a network. Does not necessarily show the critical path through a network. Answer (A) is incorrect because the critical path is not shown on a Gantt chart. Answer (B) is incorrect because linear programming is used to determine an optimal product mix. Answer (C) is incorrect because a Gantt chart shows the activities to be completed but not their sequencing. Answer (D) is correct. A Gantt or bar chart is sometimes used in conjunction with PERT or CPM to show the progress of a special project. Time is shown on the horizontal axis, the length of a bar equals the length of an activity, and shading indicates the degree of completion. However, the Gantt chart is not as sophisticated as PERT or CPM in that it does not reflect the relationships among the activities or define a critical path.

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[78] Gleim #: 1.78 -- Source: CIA 586 III-23 As of week 8, the Gantt chart shows that the project is

(Refer to Figure CIA2_08_26.)

A. B. C. D.

Complete. Ahead of schedule. On schedule. Behind schedule. Answer (A) is incorrect because the project is ahead of schedule, but activity D has not yet been started, much less completed. Answer (B) is correct. Assuming that (1) each of the bars represents the expected time necessary to complete an activity and (2) the shaded regions represent the portions completed, activity A has been completed as scheduled and activities B and C are ahead of schedule. Consequently, the project is ahead of schedule. Answer (C) is incorrect because the project is ahead of schedule, but activity D has not yet been started, much less completed. Answer (D) is incorrect because the project is ahead of schedule, but activity D has not yet been started, much less completed.

[79] Gleim #: 1.79 -- Source: CMA 694 4-1 When using PERT (Program Evaluation Review Technique), the expected time for an activity when given an optimistic time (A), a pessimistic time (B), and a most likely time (m) is calculated by which one of the following formulas?

A. B. C. D.

(b a) 2 (a + b) 2 (a + 4m + b) 6 (4abm) 6 Answer (A) is incorrect because the most likely time estimate should be included in the formula. Answer (B) is incorrect because the most likely time estimate should be included in the formula. Answer (C) is correct. PERT was developed to aid managers in controlling large, complex projects. PERT analysis includes probabilistic estimates of activity completion times. Three time estimates are made: optimistic, most likely, and pessimistic. The time estimates for an activity are assumed to approximate a beta probability distribution. PERT approximates the mean of the beta distribution by dividing the sum of the optimistic time, the pessimistic time, and four times the most likely time by six. Answer (D) is incorrect because all time estimates are not weighted equally.

[80] Gleim #: 1.80 -- Source: CIA 597 III-98 The process of adding resources to shorten selected activity times on the critical path in project scheduling is called

A. B. C. D.

Crashing. The Delphi technique. Material-requirements planning. A branch-and-bound solution.

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Answer (A) is correct. When making a cost-time trade-off, the first activity to be crashed (have its completion time accelerated) is one on the critical path. To select an activity on another path would not reduce the total time of completion. The activity chosen should have a completion time that can be accelerated at the lowest possible cost per unit of time saved. Answer (B) is incorrect because the Delphi technique is a qualitative forecasting approach. Answer (C) is incorrect because material-requirements planning is an inventory model. Answer (D) is incorrect because a branch-and-bound solution is an integer programming solution. [81] Gleim #: 1.81 -- Source: CMA 1288 5-24 California Building Corporation uses the critical path method to monitor construction jobs. The company is currently 2 weeks behind schedule on Job #181, which is subject to a $10,500-per-week completion penalty. Path A-B-C-F-G-H-I has a normal completion time of 20 weeks, and critical path A-D-E-F-G-H-I has a normal completion time of 22 weeks. The following activities can be crashed: Cost to Crash 1 Week $ 8,000 10,000 8,800 Cost to Crash 2 Weeks $15,000 19,600 19,500

Activities BC DE EF

California Building desires to reduce the normal completion time of Job #181 and, at the same time, report the highest possible income for the year. California Building should crash

A. B. C. D.

Activity BC 1 week and activity EF 1 week. Activity BC 2 weeks. Activity EF 2 weeks. Activity DE 1 week and activity EF 1 week. Answer (A) is incorrect because BC is not on the critical path. Answer (B) is incorrect because BC is not on the critical path. Answer (C) is incorrect because the cost of crashing EF 2 weeks is $19,500, which is greater than the total cost to crash DE and EF for 1 week each. Answer (D) is correct. Activities that are to be crashed in a CPM problem should be ones that are on the critical (longest) path. Thus, activity BC should not be selected because it is not on the critical path. To finish activity BC 2 weeks early would not reduce the total time to complete the project. Therefore, the only feasible choices are DE and EF on the critical path. The total cost to crash DE and EF for 1 week each is $18,800 ($10,000 + $8,800), which is less than the cost to crash either activity for 2 weeks. Thus, DE and EF should be crashed for 1 week each because the total cost is less than the $21,000 ($10,500 2) 2-week delay penalty.

[82] Gleim #: 1.82 -- Source: CMA 688 5-13 In a PERT network, the optimistic time for a particular activity is 9 weeks, and the pessimistic time is 21 weeks. Which one of the following is the best estimate of the standard deviation for the activity?

A. B. C. D.

2 6 9 12

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Answer (A) is correct. PERT analysis includes probabilistic estimates of activity completion times. Three time estimates are made: optimistic, most likely, and pessimistic. The time estimates for an activity are assumed to approximate a beta probability distribution. In contrast to the normal distribution, this distribution has finite endpoints (the optimistic and pessimistic estimates) and is unimodal; that is, it has only one mode (the most likely time). PERT approximates the mean of the beta distribution by dividing the sum of the optimistic time, the pessimistic time, and four times the most likely time (the mode) by six. The standard deviation is approximated by dividing the difference between the pessimistic and optimistic times by six. The basis for the latter approximation is that various probability distributions have tails that lie about plus or minus three standard deviations from the mean. For example, 99.9% of observations in the normal distribution are expected to lie within this range. Accordingly, if the pessimistic and optimistic times are 21 and 9 weeks, respectively, the standard deviation is 2 weeks (12 6). Answer (B) is incorrect because 6 is the approximate number of standard deviations between the tails of the normal distribution. Answer (C) is incorrect because 9 weeks is the pessimistic estimate. Answer (D) is incorrect because 12 weeks is the difference between the optimistic and the pessimistic estimates. [83] Gleim #: 1.83 -- Source: CMA 688 5-17 A PERT network has only two activities on its critical path. These activities have standard deviations of 6 and 8, respectively. The standard deviation of the project completion time is

A. B. C. D.

7 10 14 48 Answer (A) is incorrect because 7 is the average standard deviation. Answer (B) is correct. The mean time for the critical path is simply the sum of the means of the activity times. However, the standard deviation equals the square root of the sum of the variances (squares of the standard deviations) of the times for activities on the critical path. The standard deviation of the project completion time (time for the critical path) is therefore the square root of 100 (6 2 + 82), or 10. Answer (C) is incorrect because 14 is the sum of the standard deviations. Answer (D) is incorrect because 48 is the product of the standard deviations.

[Fact Pattern #8] The PERT network diagram and the corresponding activity cost chart for a manufacturing project at Networks, Inc. are presented below. The numbers in the diagram are the expected times (in days) to perform each activity in the project.

(Refer to Figure CIA3_01_08.)

Activity AB AC AD BE CE DE BC BD

Normal Cost $3,000 5,000 4,000 6,000 8,000 6,000 2,500 2,000

Crash Time 3.50 days 4.50 4.00 5.00 5.00 6.50 .50 .25

Crash Cost $4,000 5,250 4,750 7,000 9,200 6,750 3,500 2,500

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[84] Gleim #: 1.84 -- Source: CMA 1290 4-7 (Refers to Fact Pattern #8) The expected time of the critical path is

A. B. C. D.

12.0 days. 13.0 days. 11.5 days. 11.0 days. Answer (A) is incorrect because the expected time of the critical path is 13.0 days. Answer (B) is correct. The critical path is the longest path. The longest path in the diagram is A-D-E, which requires 13 days (5.5 + 7.5) based on expected times. Answer (C) is incorrect because the expected time of the critical path is 13.0 days. Answer (D) is incorrect because the expected time of the critical path is 13.0 days.

[85] Gleim #: 1.85 -- Source: CMA 1290 4-8 (Refers to Fact Pattern #8) To keep costs at a minimum and decrease the completion time by 1 1/2 days, Networks, Inc. should crash activity(ies)

A. B. C. D.

AD and AB. DE. AD. AB and CE. Answer (A) is correct. The critical (longest) path is A-D-E, which has an expected time of 13 days (see preceding question). However, to decrease the projects completion time by 1.5 days, paths A-B-C-E (4.5 + 1.0 + 6.5 = 12 days) and A-B-D-E (4.5 + .5 + 7.5 = 12.5 days) as well as A-D-E must also be shortened. Hence, A-D-E must be reduced by 1.5 days, A-B-C-E by .5 day, and A-B-D-E by 1.0 day. The only way to decrease A-D-E by 1.5 days is to crash activity AD (5.5 expective time 4.0 crash time = 1.5 days). Crashing DE results in a 1.0-day saving (7.5 6.5) only. Crashing AB is the efficient way to reduce both A-B-C-E and A-B-D-E by the desired amount of time because it is part of both paths. The incremental cost of crashing AB is $1,000 ($4,000 crash cost $3,000 normal cost) to shorten the completion time by 1.0 day (4.5 3.5). The alternatives for decreasing both A-B-C-E and A-B-D-E are more costly. Answer (B) is incorrect because crashing activity DE saves only 1.0 day (7.5 6.5) on the critical path and does not reduce the time needed for A-B-C-E. Answer (C) is incorrect because crashing AD does not reduce the time necessary to complete A-B-C-E or A-B-D-E. Answer (D) is incorrect because AB and CE are not on the critical path.

[86] Gleim #: 1.86 -- Source: CMA 694 4-3 When making a cost-time trade-off in PERT analysis, the first activity that should be crashed is the activity

A. B. C. D.

With the largest amount of slack. With the lowest unit crash cost. On the critical path with the maximum possible time reduction. On the critical path with the lowest unit crash cost.

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Answer (A) is incorrect because eliminating an activity with slack will not reduce the total time of the project. Answer (B) is incorrect because the activity with the lowest unit crash cost may not be on the critical path. Answer (C) is incorrect because the time reduction should be related to its cost. The maximum time reduction may not be cost effective. Answer (D) is correct. When making a cost-time trade-off, the first activity to be crashed (have its completion time accelerated) is one on the critical path. To select an activity on another path would not reduce the total time of completion. The initial activity chosen should be the one with the completion time that can be accelerated at the lowest possible cost per unit of time saved. [87] Gleim #: 1.87 -- Source: CMA 695 4-12 In PERT, slack is the

A. B. C. D.

Uncertainty associated with time estimates. Difference between the latest starting time and earliest finishing time. Path that has the largest amount of time associated with it. Number of days an activity can be delayed without forcing a delay for the entire project. Answer (A) is incorrect because uncertainty is reflected in the use of probabilistic estimates of completion times. Answer (B) is incorrect because the difference between the latest starting time and earliest finishing time is irrelevant. Answer (C) is incorrect because the path with the largest amount of time associated with it is the critical path. Answer (D) is correct. PERT diagrams are free-form networks showing each activity in a large project as a line between events. The critical path is the longest path in time through the network. That path is critical in that, if any activity on the critical path takes longer than expected, the entire project will be delayed. Paths that are not critical have slack time. Slack is the number of days an activity can be delayed without forcing a delay for the entire project.

[88] Gleim #: 1.88 -- Source: CIA 1196 III-96 The network below describes the interrelationships of several activities necessary to complete a project. The arrows represent the activities. The numbers between the arrows indicate the number of months to complete each activity.

(Refer to Figure CIA3_01_09.) The shortest time to complete the project is

A. B. C. D.

5 months. 6 months. 8 months. 14 months. Answer (A) is incorrect because the project cannot be completed in less than 8 months. Answer (B) is incorrect because the project cannot be completed in less than 8 months. Answer (C) is correct. The longest, or critical, path in the network from node (A) to node (F) is path A-C-D-F. All other paths are shorter than path A-C-D-F, so the activities along those paths can be completed before the activities along path A-C-D-F. Thus, the shortest time to complete the project is 8 months (3 + 3 + 2). Answer (D) is incorrect because no path through the network requires 14 months.

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[89] Gleim #: 1.89 -- Source: CIA 596 III-100 A shortest-route algorithm is used in network models to

A. B. C. D.

Identify bottlenecks in a network and hence identify the longest path. Minimize total travel time from one site to each of the other sites in a transportation system. Maximize throughput in networks with distinct entry (source node) and exit (sink node) points. Identify the set of connecting branches having the shortest combined length. Answer (A) is incorrect because the critical path method (CPM) is intended to identify bottlenecks in a network and hence identify the longest path. Answer (B) is correct. Network models are used to solve managerial problems pertaining to project scheduling, information systems design, and transportation systems design. Networks consisting of nodes and arcs may be created to represent in graphic form problems related to transportation, assignment, and transshipment. The shortest-route, minimal spanning tree, and maximal flow problems are other applications of network models. A shortest-route algorithm minimizes total travel time from one site to each of the other sites in a transportation system. Answer (C) is incorrect because the maximal flow algorithm maximizes throughput in networks with distinct entry (source node) and exit (sink node) points. Examples of applications are highway transportation systems and oil pipelines. Flows are limited by capacities of the arcs (e.g., highways or pipes). Answer (D) is incorrect because the minimal spanning tree algorithm identifies the set of connecting branches having the shortest combined length. A spanning tree is a group of branches (arcs) that connects each node in the network to every other node. An example problem is the determination of the shortest telecommunications linkage among users at remote sites and a central computer.

[90] Gleim #: 1.90 -- Source: CIA 597 III-32 Reengineering is the thorough analysis, fundamental rethinking, and complete redesign of essential business processes. The intended result is a dramatic improvement in service, quality, speed, and cost. An internal auditors involvement in reengineering should include all of the following except

A. B. C. D.

Determining whether the process has senior managements support. Recommending areas for consideration. Developing audit plans for the new system. Directing the implementation of the redesigned process. Answer (A) is incorrect because internal auditors may perform the functions of determining whether the process has senior managements support, recommending areas for consideration, and developing audit plans for the new system. Answer (B) is incorrect because internal auditors may perform the functions of determining whether the process has senior managements support, recommending areas for consideration, and developing audit plans for the new system. Answer (C) is incorrect because internal auditors may perform the functions of determining whether the process has senior managements support, recommending areas for consideration, and developing audit plans for the new system. Answer (D) is correct. Internal auditors should not become directly involved in the implementation of the redesign process. This involvement would impair their independence and objectivity. Staff assignments of internal auditors should be rotated periodically whenever it is practicable to do so.

[91] Gleim #: 1.91 -- Source: CIA 1195 I-66 Monitoring is an important component of internal control. Which of the following is not an example of monitoring?

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A. Management regularly compares divisional performance with budgets for the division. B. Data processing management regularly generates exception reports for unusual transactions or volumes of transactions and follows up with investigation as to causes. C. Data processing management regularly reconciles batch control totals for items processed with batch controls for items submitted. D. Management has asked internal auditing to perform regular audits of the controls over cash processing. Answer (A) is incorrect because budgetary comparison is a typical example of a monitoring control. Answer (B) is incorrect because investigation of exceptions is a monitoring control used by lower-level management to determine when their operations may be out of control. Answer (C) is correct. Monitoring assesses the quality of internal control over time. Management considers whether internal control is properly designed and operating as intended and modifies it to reflect changing conditions. Monitoring may be in the form of separate, periodic evaluations or of ongoing monitoring. Ongoing monitoring occurs as part of routine operations. It includes management and supervisory review, comparisons, reconciliations, and other actions by personnel as part of their regular activities. However, reconciling batch control totals is a processing control. Answer (D) is incorrect because internal auditing is a form of monitoring. It serves to evaluate managements other controls. [92] Gleim #: 1.92 -- Source: Publisher Tocon Company produces two components: A-1 and A-2. The unit throughput contribution margins for A-1 and A-2 are $150 and $300, respectively. Each component must proceed through two processes: Operation 1 and Operation 2. The capacity of Operation 1 is 180 machine hours, with A-1 and A-2 requiring 1 hour and 3 hours, respectively. Furthermore, Tocon can sell only 45 units of A-1 and 100 units of A-2. However, Tocon is considering expanding Operation 1s capacity by 90 machine hours at a cost of $80 per hour. Assuming that Operation 2 has sufficient capacity to handle any additional output from Operation 1, Tocon should produce

Units of A-1 A. B. C. D. 180 45 45 0

Units of A-2 0 100 75 60

Answer (A) is incorrect because Tocon can sell only 45 units of A-1. Answer (B) is incorrect because Tocon can produce only 75 units of A-2 if it produces 45 units of the more profitable A-1. Answer (C) is correct. A-1s throughput contribution margin per unit of the scarce resource (the internal binding constraint) is $150 ($150 UCM 1 machining hour). A-2s throughput contribution margin per unit of the scarce resource is $100 ($300 UCM 3 machine hours). Consequently, Tocon should produce as much A-1 as it can sell (45 units). If Tocon adds 90 machine hours to increase the capacity of Operation 1 to 270 hours (180 + 90), it cannot produce additional units of A-1 because the external binding constraint has not been relaxed. However, it can produce additional units of A-2. Given that the UCM per machine hour of A-2 is $100 and that the cost is $80 per hour, adding capacity to Operation 1 is profitable. Thus, Tocon should use 45 machine hours to produce 45 units of A-1. The remaining 225 machine hours (270 - 45) should be used to produce 75 units (225 3 hours) of A-2. The latter amount is within the external binding constraint. Answer (D) is incorrect because Tocon should produce as much of A-1 as it can sell. [93] Gleim #: 1.93 -- Source: Publisher Which of the following is a short-term approach to managing bottlenecks or binding constraints in production and distribution processes?

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A. B. C. D.

Theory of constraints. Reengineering. Rationalization. Micromotion study. Answer (A) is correct. The theory of constraints (TOC) is a short-term approach to managing bottlenecks (binding constraints) in production and distribution processes. Its basic principle is that short-term profit maximization requires maximizing the contribution margin of the binding constraint (the throughput contribution). Answer (B) is incorrect because reengineering an approach to business process analysis that entails process innovation and core process redesign. Instead of improving existing procedures, it finds new ways of doing things. Answer (C) is incorrect because rationalization is yet another approach to business process analysis. It is the streamlining of procedures to make automation more efficient. Answer (D) is incorrect because a micromotion study is a method used for work management, and it requires videotaping the performance of a job.

[Fact Pattern #9] This information is relevant to a theory of constraints (TOC) analysis. A manufacturer that can sell all of its output produces its sole product using three operations. Each unit sells for $120, and direct materials costing $48 per unit are added at the start of the first operation. Other variable costs are immaterial. The following annual cost and capacity information is available concerning those operations:

Operation 1 Total capacity per year Total output per year Fixed cost of operations (not including direct materials) [94] Gleim #: 1.94 -- Source: Publisher 200,000 units 150,000 units $1,200,000

Operation 2 150,000 units 150,000 units $1,800,000

Operation 3 180,000 units 150,000 units $2,250,000

(Refers to Fact Pattern #9) Assume that additional workers are hired for the bottleneck operation to expedite setups and materials handling. The cost of the additional workers is $50,000 per year. As a result, the annual output of the bottleneck operation will increase by 500 units. The change in operating income attributable to the increase in workers is

A. B. C. D.

$50,000 $36,000 $(14,000) $(20,000) Answer (A) is incorrect because $50,000 is the incremental cost. Answer (B) is incorrect because $36,000 is the incremental throughput contribution. Answer (C) is correct. Operation 2 is the bottleneck because it is functioning at its capacity. The incremental annual throughput contribution (revenues direct materials costs) from adding workers to Operation 2 is $36,000 [500 units ($120 unit price $48 DM per unit)]. Because the cost of the additional workers is $50,000, the change in operating income is $(14,000). Answer (D) is incorrect because $(20,000) is based on the assumption that an additional $12 per unit of fixed costs will be applied.

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[95] Gleim #: 1.95 -- Source: Publisher (Refers to Fact Pattern #9) Assume that X Company offers to perform the Operation 2 function on 1,000 units at a unit price of $40, excluding direct materials cost. Also assume that Y Company offers to perform the Operation 1 function on 1,000 units at a unit price of $7, excluding direct materials cost. Which of these mutually exclusive offers is acceptable?

A. B. C. D.

X but not Y. Y but not X. X or Y. Neither offer should be accepted. Answer (A) is correct. Xs offer should be accepted because its cost is $40,000 (1,000 units $40), but the increase in throughput contribution is $72,000 [1,000 units ($120 unit price $48 DM per unit)]. Hence, the relevant cost of Xs offer is less than the incremental throughput contribution. Xs offer effectively increases the capacity of the bottleneck operation. Ys offer should be rejected because, even though its $7 unit price is less than the $8 unit operating cost (excluding direct materials) for Operation 1, it will result in the incurrence of additional costs with no increase in throughput contribution, given that Operation 2 is already producing at its 150,000-unit capacity. Answer (B) is incorrect because Xs offer but not Ys offer is acceptable. Answer (C) is incorrect because Xs offer but not Ys offer is acceptable. Answer (D) is incorrect because Xs offer but not Ys offer is acceptable.

[96] Gleim #: 1.96 -- Source: Publisher Which of the following statements is not true regarding ISO 9000 standards?

A. B. C. D.

Compliance with the standards is voluntary. The ISO 9000 standards are revised every 5 years to account for technological and market developments. The objective of ISO 9000 standards is to ensure high quality products and services. ISO 9000 is a set of generic standards for establishing and maintaining a quality system within a company. Answer (A) is incorrect because compliance is voluntary but many companies are adopting the standards for competitive reasons or out of fear that the standards will become a requirement in foreign markets. Answer (B) is incorrect because the ISO rules specify that standards are periodically revised every 5 years in light of technological and market developments. Answer (C) is correct. The objective of ISO 9000 standards is to ensure consistent quality even if the quality is poor. The market will determine the quality of the end result. Answer (D) is incorrect because ISO 9000 standards are generic in nature and only ensure consistent quality in the product being produced.

[97] Gleim #: 1.97 -- Source: Publisher What is the main benefit for most companies who adopt ISO 14000 standards?

A. B. C. D.

Reduced monitoring and inspection by regulatory agencies. Companies are required to adopt ISO 14000 standards to operate in the European Union. The Environmental Protection Agency cannot use voluntary ISO audits as a basis for imposing penalties. Companies learn how well their environmental management system operates relative to those of other companies.

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Answer (A) is incorrect because not all companies are regulated by government agencies. Also, there is no guarantee that compliance with ISO 14000 standards will reduce monitoring and inspection by agencies. Answer (B) is incorrect because ISO 14000 standards are not currently required by the European Union. Answer (C) is incorrect because this is a benefit to some companies but not others. Not all companies are subject to the EPAs audits. Answer (D) is correct. The main benefit of instituting ISO 14000 standards is internal; companies learn how well their environmental management system operates relative to those of other companies. This is accomplished through the sharing of information required by ISO standards. [98] Gleim #: 1.98 -- Source: Publisher What ensures that a company is complying with the documented Quality Management System procedures and ISO 9000 standards?

A. B. C. D.

The internal audit. The registrar. On-site inspections by an external auditor. Management commitment. Answer (A) is correct. An important requirement of the ISO 9000 standards is the internal audit system. Internal audits assure that the company is complying with the documented QMS procedures and ISO 9000 standards. Answer (B) is incorrect because the registrar evaluates whether the quality control system conforms to the selected standard. Answer (C) is incorrect because the registrar is the external auditor who performs the on-site inspection. The registrar observes the quality control system and evaluates the conformity to the selected standard. Answer (D) is incorrect because the internal audit is responsible for ensuring compliance with the QMS and ISO 9000 standards. However, management commitment plays an important role in determining the amount of resources dedicated to quality.

[99] Gleim #: 1.99 -- Source: CIA 591 III-44 The following data on variables x and y was collected from June to October: June x y 24 104 July 31 76 August 19 124 September 15 140 October 22 112

The correlation coefficient between variables x and y is nearest to

A. B. C. D.

1.00 -1.00 0.50 0.00

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Answer (A) is incorrect because a positive correlation coefficient implies that one variable increases (decreases) as the other increases (decreases). The data clearly do not support this conclusion. Answer (B) is correct. A correlation coefficient of -1.00 implies a perfect inverse correlation; that is, the observations fall exactly along a straight line and the value of one variable increases (decreases) as the other decreases (increases). In the example to the left, the equation of the straight line is

y = or x =

200 4x 50 1y 4

Answer (C) is incorrect because a positive correlation coefficient implies that one variable increases (decreases) as the other increases (decreases). The data clearly do not support this conclusion. Answer (D) is incorrect because a correlation coefficient of zero implies that the two variables are unrelated. The data clearly indicate that the two variables move in opposite directions. [100] Gleim #: 1.100 -- Source: CIA 595 III-97 A company is formulating its plans for the coming year, including the preparation of its cash budget. Historically, 30% of the companys sales are cash sales. The remaining 70% are credit sales with the following collection pattern. Collections on Account In the month of sale In the month following the sale Uncollectible Percentage 40% 58% 2%

Sales for the first five months of the coming year are forecast as follows. January February March April May $3,500,000 3,800,000 3,600,000 4,000,000 4,200,000

For the month of April, the total cash receipts from sales and collections on account would be

A. B. C. D.

$3,729,968 $3,781,600 $4,025,200 $4,408,000 Answer (A) is incorrect because $3,729,968 results from improperly calculating the collections of April and March credit sales. The 2% uncollectible amount should not be removed from the credit sales before the collection percentage is applied. Answer (B) is correct. The cash receipts for April equal Aprils cash sales (30% $4,000,000 = $1,200,000), 40% of Aprils credit sales, and 58% of Marchs credit sales. Consequently, total cash receipts equal $3,781,600 [$1,200,000 + (40% 70% $4,000,000) + (58% 70% $3,600,000)]. Answer (C) is incorrect because $4,025,200 includes the collection of May credit sales rather than March credit sales. Answer (D) is incorrect because $4,408,000 improperly calculates the collections of March credit sales. The calculation treats the entire sales figure for March as credit sales.

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[101] Gleim #: 1.101 -- Source: CIA 597 III-100 The following information and diagram apply to a project:

(Refer to Figure CIA3_01_10.)

Activity A B C D E

Time (days) 5 3 4 2 6

Immediate Predecessor None None A B C, D

The earliest completion time for the project is

A. B. C. D.

11 days. 14 days. 15 days. 20 days. Answer (A) is incorrect because 11 days is the shortest, not the longest, time to completion. Answer (B) is incorrect because 14 days is not the completion time of a path to completion. Answer (C) is correct. The two paths through the network are ACE (5 + 4 + 6 = 15 days) and BDE (3 + 2 + 6 = 11 days). The critical or longest path is A-C-E. Hence, the earliest completion time is 15 days. Answer (D) is incorrect because 20 days is the sum of all of the activity times.

[102] Gleim #: 1.102 -- Source: CIA 1191 III-33 The data below were gathered on two different machine centers and two products. Product Hours per Unit A Machine Center 1 Machine Center 2 Contribution per unit 2.5 6 $4 B 4 3 $5 Hours Available 60 70

Which item below would be part of a linear programming formulation of this problem?

A. B. C. D.

Maximize: Contribution > 4A + 5B. Subject to: A < 0. Subject to: 2.5A + 4B < 60. Subject to: 4A + 5B < 130.

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Answer (A) is incorrect because the objective function is to maximize the total contribution margin (4A + 5B). This amount is not expressed as an inequality. Answer (B) is incorrect because this equation (A < 0) is nonsensical. Answer (C) is correct. The linear programming solution is subject to constraints on the availability of machine hours in both centers. For example, products A and B require 2.5 and 4 hours per unit, respectively, in Machine Center 1, but only 60 hours are available. Hence, the optimal production of A and B to the following constraint: 2.5A + 4B < 60 Answer (D) is incorrect because the hours available in the two machine centers cannot be added together. Also, the left side of the equation states the objective function, not a constraint. [103] Gleim #: 1.103 -- Source: CIA 594 II-40 Various tools are employed to control large scale projects. They include all of the following except:

A. B. C. D.

PERT. CPM. Statistical process control. Gantt charts. Answer (A) is incorrect because PERT breaks down a project into a set of events, arranges the events into a strict priority network, and establishes a completion time for each event. Answer (B) is incorrect because CPM is used to control large scale projects. Essentially a subset of PERT, CPM uses a deterministic rather than a probabilistic estimate of the time required for task completion. Answer (C) is correct. Statistical process (quality) control is not used to control large scale projects. Statistical quality control is a method of determining whether the shipment or production run of units lies within acceptable limits. It is also used to determine whether production processes are out of control. Answer (D) is incorrect because Gantt charts compare scheduled production with actual production. Its control function lies in its ability to identify variations and thus formulate corrective actions.

[104] Gleim #: 1.104 -- Source: CIA 594 III-61 Which of the following terms is not used in project management?

A. B. C. D.

Dummy activity. Latest finish. Optimistic time. Lumpy demand. Answer (A) is incorrect because a dummy activity is one that consumes no time but establishes precedence among activities. It is used specifically in project management. Answer (B) is incorrect because the latest finish is the latest that an activity can finish without causing delay in the completion of the project. Answer (C) is incorrect because optimistic time is the time for completing a project if all goes well. Answer (D) is correct. Project management concerns managing teams assigned to special projects. Lumpy demand refers to periodic demand for a product or service that increases in large, lumpy increments.

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[105] Gleim #: 1.105 -- Source: CIA 592 III-69 Activity scheduling information for the installation of a new computer system is given below.

Activity A B C D E

Immediate Predecessor A A B, D

Duration (Days) 4 3 9 6 5

For this project, the critical path is

A. B. C. D.

A-C. B-E. A-D-E. B-D-C. Answer (A) is incorrect because the path length of A-C is 13. Answer (B) is incorrect because the path length of B-E is 8. Answer (C) is correct. The critical path is the longest path because it defines the minimum duration of the project. A-DE (4 + 6 + 5 = 15) is the critical path. Answer (D) is incorrect because B-D-C is not a path. The predecessor of C is A.

[106] Gleim #: 1.106 -- Source: CIA 1191 III-37 In a critical path analysis, if slack time in an activity exists, the activity

A. B. C. D.

Is not essential to the overall project. Is a backup activity to replace a main activity should it fail. Could be delayed without delaying the overall project. Involves essentially no time to complete. Answer (A) is incorrect because an activity with slack may nevertheless be essential to the overall project. Answer (B) is incorrect because it is not a backup activity. Answer (C) is correct. Slack is the free time associated with each activity. In other words, paths that are not critical have slack time. Slack represents unused resources that can be diverted to the critical path. Answer (D) is incorrect because time is involved in a slack activity.

[107] Gleim #: 1.107 -- Source: CIA 1193 III-67 A company has several departments that conduct technical studies and prepare reports for clients. Recently, there have been long delays in having these reports copied at the companys centralized copy center because of the dramatic increase in business. Management is considering decentralizing copy services to reduce the turnaround and provide clients with timely reports. An appropriate technique for minimizing turnaround time and the cost of providing copy services is

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A. B. C. D.

Queuing theory. Linear programming. Regression analysis. Game theory. Answer (A) is correct. Two basic costs are involved in queuing (waiting-line) models: (1) the cost of providing service (including facility costs and operating costs), and (2) the cost of idle resources waiting in line. The latter may be a direct cost if paid employees are waiting, or an opportunity cost in the case of waiting customers. The objective of queuing theory is to minimize the total cost of the system, including both service and waiting costs, for a given rate of arrivals. This minimization occurs at the point at which cost of waiting is balanced by the cost of providing service. This company wishes to reduce the total of waiting costs (turnaround time) and the cost of copy services. Answer (B) is incorrect because linear programming is a mathematical technique for optimizing a given objective function subject to constraints. Answer (C) is incorrect because regression analysis is a statistical procedure for estimating the relation between variables. Answer (D) is incorrect because game theory is a mathematical approach to decision-making in which each decision-maker takes into account the courses of action of competitors.

[Fact Pattern #10] A bank has two drive-in lanes to serve customers, one attached to the bank itself, the second on an island. One teller serves both stations. The bank is interested in determining the average waiting times of customers and has developed a model based on random numbers. The two key factors are the time between successive car arrivals and the time customers wait in line. Assume that the analysis with cars just arriving at both service windows, both requiring 3 minutes of service time. Car 1 is at the attached window and car 2 at the island window. A car will always go to the window attached to the bank unless that window has more cars waiting than the island window. The lone teller will always serve the car that arrived first. If two cars arrive simultaneously, the one at the attached window will be served before the one at the island. Based on a known probability distribution, the bank assigns random numbers to arrival and service times:

Random # 1 2, 3 4, 5, 6 7, 8

Time between arrivals: 1 minute 2 minutes 3 minutes 4 minutes

Random # 1, 2 3 4, 5, 6 7, 8, 9

Service time 1 minute 2 minutes 3 minutes 4 minutes

The bank then selects random numbers for the next two cars as Random Numbers Selected

Arrival Car 3 Car 4 #3 #7

Service #7 #8

[108] Gleim #: 1.108 -- Source: CIA 1192 III-95 (Refers to Fact Pattern #10) The problem just described is best approached by use of which quantitative method?

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A. B. C. D.

Integrated autoregressive-moving average (ARIMA) modeling. Exponential smoothing, multiple parameters. Queuing theory. Linear programming. Answer (A) is incorrect because ARIMA modeling is a times-series technique. Answer (B) is incorrect because exponential smoothing is a time-series model. Answer (C) is correct. Two basic costs are involved in queuing (waiting-line) models, (1) the cost of providing service (including facility costs and operating costs), and (2) the cost of idle resources waiting in line. The latter may be a direct cost if paid employees are waiting, or an opportunity cost in the case of waiting customers. The objective of the queuing theory is to minimize the total cost of the system, including both service and waiting costs, for a given rate of arrivals. This minimization occurs at the point where the cost of waiting is balanced by the cost of providing service. Answer (D) is incorrect because linear programming optimizes outputs given scarce resources.

[109] Gleim #: 1.109 -- Source: CIA 1192 III-96 (Refers to Fact Pattern #10) The technique used in analyzing the problem is best described as

A. B. C. D.

Simulation theory. Integrated autoregressive-moving average (ARIMA) modeling. Linear programming. Differential calculus. Answer (A) is correct. Simulation is a technique for experimenting with logical/mathematical models using a computer. Despite the power of mathematics, many problems cannot be solved by known analytical methods because of the behavior of the variables and the complexity of their interactions. However, the performance of a quantitative model under uncertainty may be investigated by randomly selecting values for each of the variables in the model (based on the probability distribution of each variable) and then calculating the value of the solution. If this process is performed a large number of times, the distribution of results from the model will be obtained. Answer (B) is incorrect because ARIMA modeling is a time-series technique. Answer (C) is incorrect because linear programming optimizes outputs given scarce resources. Answer (D) is incorrect because differential calculus is used to establish optimization points.

[110] Gleim #: 1.110 -- Source: CIA 1192 III-97 (Refers to Fact Pattern #10) The process of making sure that the model measures what it is supposed to measure is called

A. B. C. D.

Statistical inference. Hypothesis testing. Confidence coefficient analysis. Validation.

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Answer (A) is incorrect because statistical inference refers to estimation or hypothesis testing. Answer (B) is incorrect because hypothesis testing relates to the testing of specific null hypotheses. Answer (C) is incorrect because confidence coefficients are an integral part of statistical estimation and hypothesis testing. Answer (D) is correct. Validation is a step in the simulation procedure. Some assurance is needed that the results of the experiment will be realistic. This assurance requires validation of the model -- often using historical data. If the model gives results equivalent to what actually happened, the model is historically valid. There is still some risk, however, that changes could make the model invalid for the future. [111] Gleim #: 1.111 -- Source: CIA 1193 III-71 The marketing department of your company is deciding on the price to charge for a key product. In setting this price, marketing needs to consider the price that a major competitor will charge for a similar product because the competitors price will affect the demand for your companys product. Similarly, in setting its price, the competitor will consider what your company will charge. An appropriate mathematical technique for analyzing such a decision is

A. B. C. D.

Game theory. Probability theory. Linear programming. Sensitivity analysis. Answer (A) is correct. Game (or decision) theory is a mathematical approach to decision making when confronted with an enemy or competitor. Games are classified according to the number of players and the algebraic sum of the payoffs. In a two-person game, if the payoff is given by the loser to the winner, the algebraic sum is zero and the game is called a zero-sum game. If it is possible for both players to profit, however, the game is a positive-sum game. Mathematical models have been developed to select optimal strategies for certain simple games. Answer (B) is incorrect because probability theory is a mathematical technique used to express quantitatively the likelihood of occurrence of an event. Answer (C) is incorrect because linear programming is a mathematical technique for optimizing a given objective subject to certain constraints. Answer (D) is incorrect because sensitivity analysis is a method for studying the effects of changes in one or more variables on the results of a decision model.

[112] Gleim #: 1.112 -- Source: CIA 592 III-64 Because of the large number of factors that could affect the demand for its new product, interactions among these factors, and the probabilities associated with different values of these factors, the marketing department would like to develop a computerized model for projecting demand for this product. By using a random-number procedure to generate values for the different factors, it will be able to estimate the distribution of demand for this new product. This method of estimating the distribution of demand for the new product is called

A. B. C. D.

Monte Carlo simulation. Linear programming. Correlation analysis. Differential analysis.

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Answer (A) is correct. Simulation is a technique in which a probabilistic process is first modeled. The inputs to the model are then varied a large number of times to estimate the distribution of possible outcomes from the model of the variable of interest. Simulations that use a random-number procedure to generate values for the inputs are referred to as Monte Carlo simulations. Answer (B) is incorrect because linear programming is a mathematical technique for maximizing or minimizing a given objective subject to certain constraints. Answer (C) is incorrect because correlation analysis is a statistical procedure for studying the relations among variables. Answer (D) is incorrect because differential analysis is a method used for decision-making that compares differences in costs (and revenues) of two or more possibilities. [113] Gleim #: 1.113 -- Source: CIA 1190 III-41 An account executive has just designed a Monte Carlo model to estimate the costs of a particular type of project. Validating the model could include all except

A. B. C. D.

Checking for errors in the computer programming. Checking that assumed probability distributions are reasonable. Comparing test results with previously validated models. Applying the model. Answer (A) is incorrect because it is part of the validation process. Answer (B) is incorrect because it is part of the validation process. Answer (C) is incorrect because it is part of the validation process. Answer (D) is correct. The Monte Carlo technique is used in a simulation to generate the individual values for a random value. An essential step in the simulation procedure is to validate the mathematical model used. This process involves not only searching for errors but also verifying the assumptions. It also should provide some assurance that the results of the experiment will be realistic. This assurance is often obtained using historical data. If the model gives results equivalent to what actually happened, the model is historically valid. There is still some risk, however, that changes could make the model invalid for the future. The model should not be implemented until this validation process is complete.

[114] Gleim #: 1.114 -- Source: CIA 593 III-65 A large fishing operation has information on the interval, time, and probabilities of shrimp schools staying beneath their fishing boats. In order to use this information to predict when and where to send their boats, which of the following techniques should be used?

A. B. C. D.

Simulation. Least squares. Queuing theory. Exponential smoothing.

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Answer (A) is correct. Simulation (Monte Carlo simulation) is a technique for experimenting with logical/mathematical models using a computer. Despite the power of mathematics, many problems cannot be solved by known analytical methods because of the behavior of the variables and the complexity of their interactions. However, the performance of a quantitative model under uncertainty may be investigated by randomly selecting values for each variable in the model (based on its probability distribution) and then calculating the value of the solution. If this process is performed many times, the distribution of results from the model will be obtained. Answer (B) is incorrect because least squares is a prediction and estimation technique using a single dependent and single or multiple independent variables. Answer (C) is incorrect because queuing theory is a waiting-line technique used to balance desirable service levels against the cost of providing more service. Answer (D) is incorrect because exponential smoothing is a forecasting technique using arbitrary weights. [115] Gleim #: 1.115 -- Source: CIA 594 III-60 Which of the following is not true about simulation models?

A. B. C. D.

They are deterministic in nature. The may involve sampling. They mathematically estimate what actual performance would be. They emulate stochastic systems. Answer (A) is correct. Simulation is a technique for experimenting with logical/mathematical models using a computer. The simulation procedure has five steps: define the objectives, formulate the model, validate the model, design the experiment, and conduct the simulation and evaluate the results. A simulation uses the laws of probability to generate values for random variables. Thus, simulation models are probabilistic, not deterministic. Answer (B) is incorrect because simulation modeling samples the operation of a system. Answer (C) is incorrect because simulation models mathematically estimate what performance would be under various conditions. Answer (D) is incorrect because simulation models are by definition stochastic or probabilistic models.

[116] Gleim #: 1.116 -- Source: CIA 593 III-66 A cost-volume-profit model developed in a dynamic environment determined that the estimated parameters used may vary between limits. Subsequent testing of the model with respect to all possible values of the estimated parameters is termed

A. B. C. D.

A sensitivity analysis. Statistical estimation. Statistical hypothesis testing. A time-series study. Answer (A) is correct. After a problem has been formulated into any mathematical model, it may be subjected to sensitivity analysis. Sensitivity analysis is a method for studying the effects of changes in one or more variables on the results of a decision model. Answer (B) is incorrect because statistical estimation involves the estimation of parameters. Answer (C) is incorrect because statistical hypothesis testing calculates the conditional probability that both the hypothesis is true and the sample results have occurred. Answer (D) is incorrect because a time-series study involves forecasting data over time.

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[117] Gleim #: 1.117 -- Source: CIA 1194 III-58 An investment company is attempting to allocate its available funds between two investment alternatives, stocks and bonds, which differ in terms of expected return and risk. The company would like to minimize its risk while earning an expected return of at least 10% and investing no more than 70% in either of the investment alternatives. An appropriate technique for allocating its funds between stocks and bonds is

A. B. C. D.

Linear programming. Capital budgeting. Differential analysis. Queuing theory. Answer (A) is correct. Linear programming is a mathematical technique for planning resource allocation that optimizes a given objective function that is subject to certain constraints. In this case, the maximum investment is constrained by a 70% limit on either investment choice. Answer (B) is incorrect because capital budgeting is used to analyze and evaluate long-term capital investments. Answer (C) is incorrect because differential analysis is used for decision making when differences in costs (revenues) for two or more options are compared. Answer (D) is incorrect because queuing theory is used to minimize the sum of the costs of waiting lines and servicing waiting lines when items arrive randomly at a service point and are serviced sequentially.

[118] Gleim #: 1.118 -- Source: CIA 1194 III-61 A company is deciding whether to purchase an automated machine to manufacture one of its products. Expected net cash flows from this decision depend on several factors, interactions among those factors, and the probabilities associated with different levels of those factors. The method that the company should use to evaluate the distribution of net cash flows from this decision and changes in net cash flows resulting from changes in levels of various factors is

A. B. C. D.

Simulation and sensitivity analysis. Linear programming. Correlation analysis. Differential analysis. Answer (A) is correct. Simulation is a technique used to describe the behavior of a real-world system over time. This technique usually employs a computer program to perform the simulation computations. Sensitivity analysis examines how outcomes change as the model parameters change. Answer (B) is incorrect because linear programming is a mathematical technique for optimizing a given objective function subject to certain constraints. Answer (C) is incorrect because correlation analysis is a statistical procedure for studying the relation between variables. Answer (D) is incorrect because differential analysis is used for decision making that compares differences in costs (revenues) of two or more options.

[119] Gleim #: 1.119 -- Source: CIA 1196 III-8 In forecasting purchases of inventory for a firm, all of the following are useful except

A. B. C. D.

Knowledge of the behavior of business cycles. Internal allocations of costs to different segments of the firm. Information on the seasonal variations in demand. Econometric modeling.

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Answer (A) is incorrect because, in time series analysis, the cyclical fluctuation in business activity is usually incorporated as an index number in the forecasting model. Answer (B) is correct. Internal allocations of costs relate to costs already incurred, that is, to sunk costs. Sunk costs are not relevant to decision making, for example, to forecasting future purchases. Answer (C) is incorrect because, in time series analysis, the seasonal variation is usually incorporated as an index number in the forecasting model. Answer (D) is incorrect because an econometric model is an application of statistical methods to economic problems. Such a model is used as a forecasting tool. [120] Gleim #: 1.120 -- Source: CMA 689 5-24 The primary difference between PERT and CPM is that

A. B. C. D.

CPM uses probabilities on the activity times and PERT does not. PERT considers activity costs and CPM does not. PERT can assign probabilities to activity times and CPM does not. CPM considers activity costs and PERT does not. Answer (A) is incorrect because CPM specifies the activity times (uses deterministic estimates). Answer (B) is incorrect because CPM but not PERT uses activity costs and considers crash times. Answer (C) is incorrect because a less significant difference between PERT and CPM is that PERT uses probabilistic estimates of completion times. CPM times are deterministic. The 1:4:1 method is typically used in PERT. Under this method, the most optimistic and pessimistic estimates are weighted equally, but the most likely estimate is weighted four times more heavily than the others. Answer (D) is correct. Both PERT and CPM are network analysis techniques. But CPM was developed independently of PERT and is widely used in the construction industry. CPM may be thought of as a subset of PERT. Like PERT, it is a network technique, but, unlike PERT, it uses deterministic time and cost estimates. Its advantages include cost estimates plus the concept of "crash" efforts and costs. Activity times are estimated for normal effort and crash effort. Crash time is the time to complete an activity assuming that all available resources were devoted to the task (overtime, extra crew, etc.). Activity costs are also estimated for normal and crash efforts. These estimates allow the project manager to estimate the costs of completing the project if some of the activities are completed on a crash basis. The network diagram is constructed in the same manner as PERT diagrams. Once the diagram is constructed, the critical paths are found for normal and crash times. More than one critical path may exist for each diagram.

[121] Gleim #: 1.121 -- Source: CMA 689 5-25 A Gantt chart

A. B. C. D.

Shows the critical path for a project. Is used for determining an optimal product mix. Shows only the activities along the critical path of a network. Does not necessarily show the critical path through a network. Answer (A) is incorrect because the critical path is not shown. Answer (B) is incorrect because linear programming is used to determine an optimal product mix. Answer (C) is incorrect because a Gantt chart shows the activities to be completed but not their relationships (sequencing). Answer (D) is correct. A Gantt or bar chart is sometimes used in conjunction with PERT or CPM to show the progress of a special project. Time is shown on the horizontal axis, the length of a bar equals the length of an activity, and shading indicates the degree of completion. However, the Gantt chart is not as sophisticated as PERT or CPM in that it does not reflect the relationships among the activities or define a critical path.

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[122] Gleim #: 1.122 -- Source: CMA 697 4-26 A regression equation

A. B. C. D.

Estimates the dependent variables. Encompasses factors outside the relevant range. Is based on objective and constraint functions. Estimates the independent variable. Answer (A) is correct. Regression analysis is used to find an equation for the linear relationship among variables. The behavior of the dependent variable is explained in terms of one or more independent variables. Regression analysis is often used to estimate a dependent variable (such as cost) given a known independent variable (such as production). Answer (B) is incorrect because regression results are limited to observations within the relevant range. Answer (C) is incorrect because regression analysis does not use constraint functions. Answer (D) is incorrect because the dependent variable is estimated using regression analysis.

[123] Gleim #: 1.123 -- Source: CMA 1285 5-27 The correlation coefficient that indicates the weakest linear association between two variables is

A. B. C. D.

-0.73 -0.11 0.12 0.35 Answer (A) is incorrect because -0.73 signifies a strong negative correlation. Answer (B) is correct. The correlation coefficient can vary from -1 to +1. A -1 relationship indicates a perfect negative correlation, and a +1 relationship indicates a perfect positive correlation. A zero correlation coefficient would indicate no association between the variables. Thus, the correlation coefficient that is nearest to zero would indicate the weakest linear association. Of the options given in the question, the correlation coefficient that is nearest to zero is -0.11. Answer (C) is incorrect because 0.12 is a slightly stronger correlation. Answer (D) is incorrect because 0.35 is a considerably stronger correlation.

[124] Gleim #: 1.124 -- Source: CMA 1289 5-14 Correlation is a term frequently used in conjunction with regression analysis and is measured by the value of the coefficient of correlation, r. The best explanation of the value r is that it

A. B. C. D.

Is always positive. Interprets variances in terms of the independent variable. Ranges in size from negative infinity to positive infinity. Is a measure of the relative relationship between two variables.

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Answer (A) is incorrect because the coefficient is negative if the relationship between the variables is inverse. Answer (B) is incorrect because the coefficient relates the two variables to each other. Answer (C) is incorrect because the size of the coefficient varies between -1.0 and +1.0. Answer (D) is correct. The coefficient of correlation (r) measures the strength of the linear relationship between the dependent and independent variables. The magnitude of r is independent of the scales of measurement of x and y. The coefficient lies between -1.0 and +1.0. A value of zero indicates no linear relationship between the x and y variables. A value of +1.0 indicates a perfectly direct relationship, and a value of -1.0 indicates a perfectly inverse relationship. [125] Gleim #: 1.125 -- Source: CMA 1293 4-25 The four components of time series data are secular trend, cyclical variation, seasonality, and random variation. The seasonality in the data can be removed by

A. B. C. D.

Multiplying the data by a seasonality factor. Ignoring it. Taking the weighted average over four time periods. Subtracting a seasonality factor from the data. Answer (A) is incorrect because adding a seasonality factor to, or subtracting it from, a forecast based on trend analysis is a means of adjusting for seasonality. Answer (B) is incorrect because seasonality factors cannot be ignored; they are reflected in the data and must be considered for a model to be accurate. Answer (C) is correct. Time series analysis relies on past experience. Changes in the value of a variable may have several possible components including secular trends, cyclical variation, seasonality, and random variation. Seasonal variations are common in many businesses. A variety of methods exist for including seasonal variations in a forecasting model, but most methods use a seasonal index. Alternatively, seasonal variations can be removed from data by using a weighted average of several time periods instead of data from individual periods. Answer (D) is incorrect because the seasonality adjustment for a single seasons data may be an increase or a decrease.

[126] Gleim #: 1.126 -- Source: CMA 696 4-20 A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the consequences of possible prediction errors is

A. B. C. D.

Expected value analysis. Learning curve analysis. Sensitivity analysis. Regression analysis. Answer (A) is incorrect because expected value is the probabilistically weighted average of the outcomes of an action. Answer (B) is incorrect because learning curve analysis quantifies how labor costs decline as employees learn their jobs through repetition. Answer (C) is correct. Sensitivity analysis determines how a result varies with changes in a given variable or parameter in a mathematical decision model. For example, in a present value analysis, a manager might first calculate the net present value or internal rate of return assuming that a new asset has a 10-year life. The NPV or IRR can then be recalculated using a 5-year life to determine how sensitive the result is to the change in the assumption. Answer (D) is incorrect because regression, or least squares, analysis determines the average change in the dependent variable given a unit change in one or more independent variables.

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[Fact Pattern #11] An international nonprofit organization finances medical research. The majority of its revenue and support comes from fund-raising activities, investments, and specific grants from an initial sponsoring corporation. The organization has been in operation over 15 years and has a small internal audit department. The organization has just finished a major fundraising drive that raised $500 million for the current fiscal period. The following are selected data from recent financial statements (dollar figures in millions):

Current Year Revenue Investments (average balances) Medical research grants made Investment income Administrative expense [127] Gleim #: 1.127 -- Source: CIA 597 I-31 $500 210 418 16 10

Past Year $425 185 325 20 8

(Refers to Fact Pattern #11) The auditor wishes to determine if the change in investment income during the current year was due to (a) changes in investment strategy, (b) changes in portfolio mix, or (c) other factors. Which of the following analytical review procedures should the auditor use?

A. Simple linear regression that compares investment income changes over the past 5 years to determine the nature of the changes. B. Ratio analysis that compares changes in the investment portfolio on a monthly basis. C. Trend analysis that compares the changes in investment income as a percentage of total assets and of investment assets over the past 5 years. D. Multiple regression analysis that includes independent variables related to the nature of the investment portfolio and market conditions. Answer (A) is incorrect because simple linear regression is based on just one independent variable. Answer (B) is incorrect because ratio analysis measure changes but do not explain them. Answer (C) is incorrect because trend analysis measure changes but do not explain them. Answer (D) is correct. Regression analysis develops an equation to explain the behavior of a dependent variable (for example, investment income) in terms of one or more independent variables (for example, market risk and the risks of particular investments). Multiple regression analysis is the best approach because it allows the auditor to regress the change in investment income on more than one independent variable. [128] Gleim #: 1.128 -- Source: CIA R98 III-35 Which of the following will allow a manufacturer with limited resources to maximize profits?

A. B. C. D.

The Delphi technique. Exponential smoothing. Regression analysis. Linear programming.

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Answer (A) is incorrect because the Delphi technique is an approach in which the manager solicits opinions on a problem from experts, summarizes the opinions, and feeds the summaries back to the experts (without revealing any of the participants to each other). The process is reiterated until the opinions converge on an optimal solution. Answer (B) is incorrect because under exponential smoothing, each forecast equals the sum of the last observation times the smoothing constant, plus the last forecast times one minus the constant. Thus, exponential means that greater weight is placed on the most recent data, with the weights of all data falling off exponentially as the data age. Answer (C) is incorrect because regression analysis is used to fit a linear trend line to a dependent variable based on one or more independent variables. Answer (D) is correct. Linear programming is a technique used to optimize an objective function, that is, to maximize a revenue or profit function or to minimize a cost function, subject to constraints, e.g., limited (scarce) resources or minimum/maximum levels of production, performance, etc. In business, linear programming is used for planning resource allocations. Managers are often faced with problems of selecting the most profitable or least costly way to use available resources. [129] Gleim #: 1.129 -- Source: CIA R98 III-36 Which of the following is not an appropriate time series forecasting technique?

A. B. C. D.

Least squares. Exponential smoothing. The Delphi technique. Moving averages. Answer (A) is incorrect because regression (least squares) analysis extends correlation to find an equation for the linear relationship among variables. The behavior of the dependent variable is explained in terms of one or more independent variables. Thus, regression analysis determines functional relationships among quantitative variables. Answer (B) is incorrect because, under exponential smoothing, each forecast equals the sum of the last observation times the smoothing constant, plus the last forecast times one minus the constant. Thus, exponential means that greater weight is placed on the most recent data, with the weights of all data falling off exponentially as the data age. Answer (C) is correct. The Delphi technique is an approach in which the manager solicits opinions on a problem from experts, summarizes the opinions, and feeds the summaries back to the experts (without revealing any of the participants to each other). The process is reiterated until the opinions converge on an optimal solution. Thus, the Delphi technique is a qualitative, not a quantitative, method. Answer (D) is incorrect because a moving average is the simplest form of smoothing. Each forecast is based on a fixed number of prior observations.

[130] Gleim #: 1.130 -- Source: CIA 1184 III-12 Which of the following observations concerning quality control is more accurate?

A. Process quality control is used when examining the quality of goods or services which already exist. B. Process quality control is used to prevent defects, whereas product quality control is used primarily to identify defects after the fact. C. Product quality control is designed to balance the marketability of higher quality against the cost of attaining higher quality. D. Product quality control is more important than process quality control.

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Answer (A) is incorrect because it describes product (not process) quality control. Answer (B) is correct. Process analysis studies the means of producing a product with a view to lowering costs and increasing efficiency while producing items of appropriate quality. The effect of process analysis is to act as a pre-control to prevent defects. Product quality control involves inspection during production to eliminate defective items. Answer (C) is incorrect because it is applicable to process (not product) quality control. Answer (D) is incorrect because process quality control and product quality control are both important elements in a quality control program. [131] Gleim #: 1.131 -- Source: CIA 594 III-53 Which statement best describes Total Quality Management (TQM)?

A. B. C. D.

TQM emphasizes reducing the cost of inspection. TQM emphasizes participation by all employees in the decision-making process. TQM emphasizes encouraging cross-functional teamwork. TQM emphasizes doing each job right the first time. Answer (A) is incorrect because TQM has a broader emphasis. It focuses on improving quality, reducing cycle time, providing increased customer satisfaction, and achieving the lowest overall business cost. Reducing the cost of inspection helps achieve the lowest overall business cost. Answer (B) is incorrect because this statement describes participative management. Answer (C) is incorrect because TQM has a broader emphasis. It focuses on improving quality, reducing cycle time, providing increased customer satisfaction, and achieving the lowest overall business cost. Encouraging cross-functional teamwork helps achieve the lowest overall business cost. Answer (D) is correct. TQM establishes quality as an organizational objective and views it as a major component of the organizations service to its customers. It emphasizes employee training and commitment, product/service design and production, and customer service. Ordinarily, the quality of a product or service is as important to customers as cost and timeliness. Superior product quality is not attained merely through more inspection, better statistical quality control, and cross-functional teamwork. Manufacturers must make fundamental changes in the way they produce products and do each job right the first time.

[132] Gleim #: 1.132 -- Source: CIA 1191 III-11 The operations manager of a company notified the treasurer of that organization 60 days in advance that a new, expensive piece of machinery was going to be purchased. This notification allowed the treasurer to make an orderly liquidation of some of the companys investment portfolio on favorable terms. What type of control was involved?

A. B. C. D.

Feedback. Strategic. Budgetary. Feedforward. Answer (A) is incorrect because feedback controls apply to decision making based on evaluations of past performance. Answer (B) is incorrect because strategic controls are broad-based and affect an organization over a long period. They apply to such long-term variables as quality and R&D. Answer (C) is incorrect because control of budgeted expenditures is not mentioned in the example. Answer (D) is correct. Feedforward control provides for the active anticipation of problems so that they can be avoided or resolved in a timely manner. Another example is the quality control inspection of raw materials and work-in-process to avoid defective finished goods.

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[133] Gleim #: 1.133 -- Source: CIA 592 III-17 As part of a Total Quality Control program, a firm not only inspects finished goods but also monitors product returns and customer complaints. Which type of control best describes these efforts?

A. B. C. D.

Feedback control. Feedforward control. Production control. Inventory control. Answer (A) is correct. A feedback control measures actual performance, something that has already occurred, to ensure that a desired future state is attained. It is used to evaluate the past to improve future performance. Inspecting finished goods, monitoring product returns, and evaluating complaints are post-action controls intended to eliminate deviations in future cycles of the process under control. Answer (B) is incorrect because feedforward controls anticipate problems before they occur. Answer (C) is incorrect because customer complaints are not part of production control. Answer (D) is incorrect because TQC, which is often associated with JIT systems but is applicable to other environments, is a philosophy emphasizing that each member of the organization is a quality control inspector. It deemphasizes the role of separate quality control departments by making each employee responsible for his/her work. Hence, TQC is not limited to inventory control.

[134] Gleim #: 1.134 -- Source: CIA 1191 III-10 To be successful, large companies must develop means to keep the organization focused in the proper direction. Organizational control systems help keep companies focused. These control systems consist of which three basic components?

A. B. C. D.

Budgeting, financial ratio analysis, and cash management. Objectives, standards, and an evaluation-reward system. Role analysis, team building, and survey feedback. Setting goals, empowering employees, and job enrichment. Answer (A) is incorrect because budgeting, financial ratio analysis, and cash management are means of financial control. Answer (B) is correct. An organizational control system must be based on a statement of what is to be achieved and when (objectives). The accomplishment of objectives depends on the establishment of standards that serve as feedforward controls. Adherence to performance standards signifies that an organization is on course to attain its objectives. A well-developed evaluation-reward system that is clearly communicated to employees should motivate them to improved performance. Answer (C) is incorrect because role analysis, team building, and survey feedback are used in developmental efforts to correct organizational deficiencies. Answer (D) is incorrect because goal setting, empowerment, and job enrichment are all motivational strategies.

[135] Gleim #: 1.135 -- Source: CIA 588 III-12 Performance appraisal systems might use any of three different approaches: (1) who did the job, (2) how the job was done, or (3) what was accomplished. Which approach is used by a system that places the focus on how the job was done?

A. B. C. D.

Behavior-oriented. Goal-oriented. Trait-oriented. Employee-oriented.

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Answer (A) is correct. Behavior-oriented performance evaluation rewards the behavior that is desired by management. Behavior control involves examining work processes rather than work output. Answer (B) is incorrect because the goal-oriented approach measures how well the employee attained the objectives or goals set by management. Answer (C) is incorrect because a trait-oriented approach tends to reward what the supervisor thinks of the employee rather than the job the employee did. Answer (D) is incorrect because an employee-oriented approach would focus on who did the job. [136] Gleim #: 1.136 -- Source: CIA 592 III-7 Identify the management technique in which employees assist in setting goals, making decisions, solving problems, and designing and implementing organizational changes.

A. B. C. D.

Total quality control. Job enlargement. Kanban. Participative management. Answer (A) is incorrect because TQC is a quality control program in which everyone sees quality control as his/her job. Answer (B) is incorrect because job enlargement refers to increasing the number of tasks one must perform. Answer (C) is incorrect because kanban is a manual inventory technique used in just-in-time inventory control systems. Answer (D) is correct. According to Marshall Soshkin ["Participative Management is an Ethical Imperative," Organizational Dynamics 12 (Spring 1984): 4-22] employees may participate in goal setting, decision making, problem solving, and designing and implementing change. Subject to various individual (values and attitudes), organizational (e.g., job design and company culture), and environmental (such as technological change and competition) contingencies, workers who participate in the aforementioned ways should experience greater autonomy and find their tasks more meaningful. In turn, this experience should lead to satisfaction, challenge, security, and acceptance and commitment. Ultimate results are innovation and improved performance and productivity.

[137] Gleim #: 1.137 -- Source: Publisher Is PERT analysis a control tool or a planning tool?

Planning A. B. C. D. Yes Yes No No

Control No Yes Yes No

Answer (A) is incorrect because PERT is a control tool as well as a planning tool. Answer (B) is correct. PERT (Program Evaluation Review Technique) is applied in the management of complex projects. It analyzes the project in terms of its component activities and determines their sequencing and timing. Thus, it systematically combines planning with control. Answer (C) is incorrect because PERT is a planning tool. Answer (D) is incorrect because PERT is a planning tool.

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[138] Gleim #: 1.138 -- Source: CIA 1196 III-60 ISO 9000 standards for ring networks include fault management, configuration management, accounting management, security management, and performance monitoring. Which of the following controls is included in the performance-monitoring standards?

A. B. C. D.

Reporting the failure of network fiber-optic lines. Recording unauthorized access violations. Compiling statistics on the number of times that application software is used. Allocating network costs to system users of the network. Answer (A) is incorrect because the failure of network fiber-optic lines is a fault management control. Answer (B) is incorrect because recording unauthorized access violations is a security management control. Answer (C) is correct. The ISO 9000 performance-monitoring standards pertain to managements ongoing assessment of the quality of performance over time. Recording software usage is a performance-monitoring control concerned with the extent and efficiency of network software use. Answer (D) is incorrect because allocating network costs to system users of the network is an accounting management control.

[139] Gleim #: 1.139 -- Source: CIA 596 III-32 If a company is customer-centered, its customers are defined as

A. B. C. D.

Only people external to the company who have purchased something from the company. Only people internal to the company who directly use its product. Anyone external to the company and those internal who rely on its product to get their job done. Everybody external to the company who is currently doing, or may in the future do, business with the company. Answer (A) is incorrect because customers are internal as well as external. Answer (B) is incorrect because customers are internal as well as external. Answer (C) is correct. One of the tenets of TQM is customer orientation, whether the customer is internal or external. An internal customer is a member of the organization who relies on another members work to accomplish his/her task. Answer (D) is incorrect because customers are internal as well as external.

[140] Gleim #: 1.140 -- Source: CIA 596 III-20 Which one of the following is not a characteristic of an innovative manufacturing company?

A. B. C. D.

Emphasis on continuous improvement. Responsiveness to the changing manufacturing environment. Emphasis on existing products. Improved customer satisfaction through product quality.

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Answer (A) is incorrect because continuous improvement is important for achieving and maintaining high levels of performance. Answer (B) is incorrect because more and more manufacturers are automating to achieve high quality, deliver customized products on time, minimize inventory, and increase flexibility. Answer (C) is correct. Innovative companies are customer driven. Because customers demand ever better quality and competitors are attempting to provide that quality, continuous improvement (called kaizen by the Japanese) is essential for such companies. Thus, the flow of innovative products and services must be continuous. Simply emphasizing existing products is not an effective strategy for most organizations. Answer (D) is incorrect because customer satisfaction is the highest priority according to modern management practice. [141] Gleim #: 1.141 -- Source: CIA 594 III-57 Which of the following is an example of an efficiency measure?

A. B. C. D.

The rate of absenteeism. The goal of becoming a leading manufacturer. The number of insurance claims processed per day. The goal of increasing market share. Answer (A) is incorrect because the rate of absenteeism does not compare input and output. Answer (B) is incorrect because the goal of becoming a leading manufacturer concerns effectiveness, not efficiency. Answer (C) is correct. An organizational structure is efficient if it facilitates the accomplishment of organizational objectives with minimum resources and fewest unsought consequences. An efficient organizational structure maximizes output for a given amount of input. Thus, an efficiency measure compares input to output. Insurance claims processed per day relates output (claims processed) to input (a days work). Answer (D) is incorrect because the goal of increasing market share concerns effectiveness, not efficiency.

[142] Gleim #: 1.142 -- Source: Publisher Goal congruence is

A. B. C. D.

The desire and the commitment to achieve a specific goal. The sharing of goals by supervisors and subordinates. The extent to which individuals have the authority to make decisions. The extent of the attempt to accomplish a specific goal. Answer (A) is incorrect because motivation is the desire and the commitment to achieve a specific goal. Answer (B) is correct. Goal congruence is agreement on the goals of the organization and/or the segment by both supervisors and subordinates. Performance is assumed to be optimized when there is an understanding that personal and segmental goals be consistent with those of the organization. Answer (C) is incorrect because autonomy is the extent to which individuals have the authority to make decisions. Answer (D) is incorrect because managerial effort is the extent of the attempt to accomplish a specific goal.

[143] Gleim #: 1.143 -- Source: CIA 596 II-1 A company, which has many branch stores, has decided to benchmark one of its stores for the purpose of analyzing the accuracy and reliability of branch store financial reporting. Which one of the following is the most likely measure to be included in a financial benchmark?

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A. B. C. D.

High turnover of employees. High level of employee participation in setting budgets. High amount of bad debt write-offs. High number of suppliers. Answer (A) is incorrect because turnover of employees is not a financial benchmark. Answer (B) is incorrect because employee participation in setting budgets is not a financial benchmark. Answer (C) is correct. A high level of bad debt write-offs could indicate fraud, which would compromise the accuracy and reliability of financial reports. Bad debt write-offs may result from recording fictitious sales. Answer (D) is incorrect because the number of suppliers is not a financial benchmark.

[144] Gleim #: 1.144 -- Source: CIA 596 III-23 Which statement best describes the emphasis of total quality management (TQM)?

A. B. C. D.

Reducing the cost of inspection. Implementing better statistical quality control techniques. Doing each job right the first time. Encouraging cross-functional teamwork. Answer (A) is incorrect because reducing the cost of inspection is a detail of the TQM emphasis. Answer (B) is incorrect because implementing better statistical quality control techniques is a detail of the TQM emphasis. Answer (C) is correct. The basic principles of TQM include doing each job right the first time, being customer oriented, committing the company culture to continuous improvement, and building teamwork and employee empowerment. Answer (D) is incorrect because encouraging cross-functional teamwork is a detail of the TQM emphasis.

[145] Gleim #: 1.145 -- Source: CIA 1196 III-92 Quality cost indices are often used to measure and analyze the cost of maintaining or improving the level of quality. Such indices are computed by dividing the total cost of quality over a given period by some measure of activity during that period (for example, sales dollars). The following cost data are available for a company for the month of March. The companys quality cost index is calculated using total cost of quality divided by sales dollars. Sales Direct materials cost Direct labor cost Testing and inspection cost Scrap and rework cost Quality planning cost Cost of customer complaints and returns $400,000 100,000 80,000 6,400 16,800 2,800 4,000

The quality cost index for March is

A. B. C. D.

7.5% 6.5% 22.0% 5.9%

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Answer (A) is correct. The total cost of quality equals the sum of prevention costs (quality planning), appraisal costs (testing and inspection), internal failure costs (scrap and rework), and external failure costs (customer complaints and returns), or $30,000 ($2,800 + $6,400 + $16,800 + $4,000). The quality cost index equals the total costs of quality, divided by sales, times 100%. Thus, the quality cost index for March is 7.5% [($30,000 $400,000) 100%]. Answer (B) is incorrect because 6.5% does not include the $4,000 cost of customer complaints. Answer (C) is incorrect because 22.0% equals the sum of direct labor and testing and inspection costs, divided by sales. Answer (D) is incorrect because 5.9% does not include testing and inspection cost in quality costs. [146] Gleim #: 1.146 -- Source: CIA 1196 III-23 The most important component of quality control is

A. B. C. D.

Ensuring goods and services conform to the design specifications. Satisfying upper management. Conforming with ISO-9000 specifications. Determining the appropriate timing of inspections. Answer (A) is correct. The intent of quality control is to ensure that goods and services conform to the design specifications. Whether the focus is on feedforward, feedback, or concurrent control, the emphasis is on ensuring product or service conformity. Answer (B) is incorrect because quality control is geared towards satisfying the customer, not upper management. Answer (C) is incorrect because ensuring the conformance with ISO-9000 specifications is a component of a compliance audit, not quality control. Answer (D) is incorrect because determining the appropriate timing of inspections is only one step towards approaching quality control. Consequently, it is not the primary component of the quality control function.

[147] Gleim #: 1.147 -- Source: CMA 693 3-13 Product-quality-related costs are part of a total quality control program. A product-quality-related cost incurred in detecting individual products that do not conform to specifications is an example of a(n)

A. B. C. D.

Prevention cost. Appraisal cost. External failure cost. Opportunity cost. Answer (A) is incorrect because prevention costs are incurred in an attempt to avoid defective output. Answer (B) is correct. Quality-related costs can be subdivided into four categories: external failure costs, internal failure costs, prevention costs, and appraisal costs. Appraisal costs embrace such activities as statistical quality control programs, inspection, and testing. Thus, the cost of detecting nonconforming individual products is an appraisal cost. Answer (C) is incorrect because external failure costs arise when quality problems occur after shipment. Answer (D) is incorrect because opportunity costs are not specifically associated with product quality. Opportunity cost is the maximum benefit forgone by using a scarce resource for a given purpose; it is the benefit provided by the next best use of that resource.

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[148] Gleim #: 1.148 -- Source: CMA 694 3-16 In 2004, a manufacturer instituted a total quality management (TQM) program producing the following report (in currency units): Summary Cost of Quality Report (000s) 2003 Prevention costs Appraisal costs Internal failure costs External failure costs Total quality costs 200 210 190 1,200 1,800 2004 300 315 114 621 1,350 % Change +50 +50 -40 -48 -25

On the basis of this report, which one of the following statements is most likely true?

A. An increase in conformance costs resulted in a higher quality product and therefore resulted in a decrease in nonconformance costs. B. An increase in inspection costs was solely responsible for the decrease in quality costs. C. Quality costs such as scrap and rework decreased by 48%. D. Quality costs such as returns and repairs under warranty decreased by 40%. Answer (A) is correct. TQM emphasizes the suppliers relationship with the customer and recognizes that everyone in a process is at some time a customer or supplier of someone else, either within or outside the organization. The costs of quality include costs of conformance and costs of nonconformance. Costs of conformance include prevention costs and appraisal (inspection) costs. Nonconformance costs are composed of internal failure costs and external failure costs, such as lost opportunity. Conformance costs (prevention and appraisal) increased substantially, whereas the nonconformance costs (internal and external failure) decreased. Hence, the increase in conformance costs resulted in a higher quality product. Answer (B) is incorrect because prevention costs also increased substantially, which could also have led to higher quality products. Answer (C) is incorrect because scrap and rework are internal failure costs, which decreased by 40%. Answer (D) is incorrect because returns and repairs are external failure costs, which decreased by 48%. [149] Gleim #: 1.149 -- Source: CIA 1184 III-11 Which of the following statements best describes the relationship between planning and controlling?

A. B. C. D.

Planning looks to the future; controlling is concerned with the past. Planning and controlling are completely independent of each other. Planning prevent problems; controlling is initiated by problems which have occurred. Controlling cannot operate effectively without the tools provided by planning.

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Answer (A) is incorrect because a control system looks to the future when it provides for corrective action and review and revision of standards. Answer (B) is incorrect because planning and controlling overlap. Answer (C) is incorrect because comprehensive planning includes creation of controls. Answer (D) is correct. Control is the process of making certain that plans are achieving the desired objectives. A control system operates through establishing standards of performance, measuring actual performance, analysis and comparison of performance with standards, taking corrective action, and reviewing and revising standards. Planning provides needed tools for the control process by establishing standards, e.g., budgets. [150] Gleim #: 1.150 -- Source: CIA 593 III-63 A firm must decide the mix of production of Product X and Product Y. There are only two resources used in the two products, resources A and B. Data related to the two products is given in the following table: Products X Resource A Resource B Unit Profit 3 2 $8 Y 7 1 $6

What is the appropriate objective function to maximize profit?

A. B. C. D.

3X + 7Y 2X + Y 8X + 6Y 5X + 8Y Answer (A) is incorrect because 3X + 7Y is a constraint. Answer (B) is incorrect because 2X + Y is a constraint. Answer (C) is correct. The objective function is the function to be optimized. This firm wishes to maximize profits on the sales of two products (X and Y). Based on profits per unit ($8 and $6, respectively), the objective function is 8X + 6Y. Answer (D) is incorrect because 5X + 8Y is the sum of the constraints.

[151] Gleim #: 1.151 -- Source: CIA R98 III-32 An appropriate technique for planning and controlling manufacturing inventories, such as raw materials, components, and subassemblies whose demand depends on the level of production is

A. B. C. D.

Materials requirements planning. Regression analysis. Capital budgeting. Linear programming.

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Answer (A) is correct. Materials requirements planning (MRP) is a system that translates a production schedule into requirements for each component needed to meet the schedule. It is usually implemented in the form of a computer-based information system designed to plan and control raw materials used in production. It assumes that forecasted demand is reasonably accurate and that suppliers can deliver based upon this accurate schedule. MRP is a centralized push-through system; output based on forecasted demand is pushed through to the next department or to inventory. Answer (B) is incorrect because regression analysis is used to fit a linear trend line to a dependent variable based on one or more independent variables. Answer (C) is incorrect because capital budgeting is the process of planning expenditures for long-lived assets. It involves choosing among investment proposals using a ranking procedure. Answer (D) is incorrect because linear programming is a decision model concerned with allocating scarce resources to maximize profit or minimize costs. [152] Gleim #: 1.152 -- Source: IIA, adapted The costs of quality that are incurred in detecting units of product that do not conform to product specifications are referred to as

A. B. C. D.

Prevention costs. Appraisal costs. Rework costs. Failure costs. Answer (A) is incorrect because prevention costs are incurred to prevent the production of products that do not conform to specifications. Answer (B) is correct. Appraisal embraces such activities as statistical quality control programs, inspection, and testing. Appraisal costs are those costs (such as test equipment maintenance and destructive testing) incurred to detect which products do not conform to specifications. Answer (C) is incorrect because rework costs, a type of failure cost, are incurred when a nonconforming product is detected and corrections are made. Answer (D) is incorrect because failure costs are incurred in the repair of nonconforming products.

[153] Gleim #: 1.153 -- Source: IIA, adapted The use of teams in total quality management is important because

A. B. C. D.

Well-managed teams can be highly creative and are able to address complex problems better than individuals can. Teams are quicker to make decisions, thereby helping to reduce cycle time. Employee motivation is higher for team members than for individual contributors. The use of teams eliminates the need for supervision, thereby allowing a company to become leaner and more profitable. Answer (A) is correct. Teams can use the diverse knowledge and skills of all team members. Employee involvement means training and empowering employees to harness their creativity for problem solving. Quality control circles are used to obtain input from employees and to locate the best perspective on problem solving. Answer (B) is incorrect because teams are often inefficient and costly. Answer (C) is incorrect because, although employee motivation may be high in teams, the high motivation does not always translate directly to quality improvement. Answer (D) is incorrect because, although need for supervision may be reduced, it is not eliminated.

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[154] Gleim #: 1.154 -- Source: IIA, adapted Which of the following is a major element of the ISO 9000:2000 quality management system standards?

A. B. C. D.

The principle that improved employee satisfaction will lead to increased productivity. The attitude and actions of the board and management regarding the significance of control within the organization. The assessment of the risk that objectives are not achieved. A requirement for organizations to monitor information on customer satisfaction as a measure of performance. Answer (A) is incorrect because this is not a part of the ISO 9000 standards. ISO argues that following the eight management principles that underlie the ISO 9000 standards will lead to improved employee satisfaction. Answer (B) is incorrect because this is the control environment as defined in the glossary of The IIAs Standards; there is no direct reference to any such concept in the ISO 9000 standards. Answer (C) is incorrect because the ISO 9000 approach does not take a risk assessment approach; a risk assessment approach is what underlies internal auditing. Answer (D) is correct. ISO 9001:2000, Quality Management Systems Requirements, is the standard that provides a model for quality assurance programs. Organizations are required to monitor information on customer satisfaction as a measure of performance. This is one of the major changes to the ISO 9000 standards made in the 2000 revision.

[155] Gleim #: 1.155 -- Source: IIA, adapted The sales manager for a builder of custom yachts developed the following conditional table for annual production and sales Demand Probability 10 0.1 20 0.2 30 0.5 50 0.2

Yachts Built 10 20 30 50 10 0 -10 -30

Expected Profit 10 20 10 -10 10 20 30 10 10 20 30 50

According to the table, how many yachts should be built?

A. B. C. D.

10 20 30 50 Answer (A) is incorrect because of the following computation: 0.1($10) + 0.2($10) + 0.5($10) + 0.2($10) = $10. Answer (B) is incorrect because of the following computation: 0.1($0) + 0.2($20) + 0.5($20) + 0.2($20) = $18. Answer (C) is correct. To achieve the maximum expected profit, 30 yachts should be built. For each level of production, multiply the probability of demand by the expected profit. The computation is: 0.1(-$10) + 0.2($10) + 0.5($30) + 0.2($30) = $22. Answer (D) is incorrect because of the following computation: 0.1(-$30) + 0.2(-$10) + 0.5($10) + 0.2($50) = $10.

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[156] Gleim #: 1.156 -- Source: IIA, adapted All of the following are useful for forecasting the needed level of inventory except

A. B. C. D.

Knowledge of the behavior of business cycles. Internal accounting allocations of costs to different segments of the company. Information about seasonal variations in demand. Econometric modeling. Answer (A) is incorrect because knowing the behavior of business cycles can be valuable when forecasting the required purchases of inventory. Answer (B) is correct. Forecasts are the basis for business plans. Models are used in the forecasting process to make decisions that optimize future results. Internal accounting allocations of costs to different segments of the company are arbitrary assignments of already incurred costs that do not have anything to do with forecasting demand. Answer (C) is incorrect because understanding seasonal variations in demand for the product can be valuable when forecasting the required purchases of inventory. Answer (D) is incorrect because using econometric models can be valuable when forecasting the required purchases of inventory.

[157] Gleim #: 1.157 -- Source: IIA, adapted The process of adding resources to shorten selected activity times on the critical path in project scheduling is called

A. B. C. D.

Crashing. The Delphi technique. ABC analysis. A branch-and-bound solution. Answer (A) is correct. Activity times are estimated for normal effort and crash effort. Crashing is the process of adding resources to shorten activity times on the critical path in project scheduling. Answer (B) is incorrect because the Delphi technique is a qualitative forecasting approach. Answer (C) is incorrect because ABC analysis is an inventory model. Answer (D) is incorrect because the branch-and-bound solution is an integer programming solution.

[158] Gleim #: 1.158 -- Source: IIA, adapted Which of the following will allow a manufacturer with limited resources to maximize profits?

A. B. C. D.

The Delphi technique. Exponential smoothing. Regression analysis. Linear programming.

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Answer (A) is incorrect because the Delphi technique is a qualitative forecasting method that obtains forecasts through group consensus. Answer (B) is incorrect because exponential smoothing is a forecasting technique that uses past time series values to arrive at forecasted values. Answer (C) is incorrect because regression analysis is a statistical technique used to develop forecasts based on the relationship between two or more variables. Answer (D) is correct. Linear programming is a mathematical technique for maximizing or minimizing a given objective subject to certain constraints. It is the correct technique to optimize the problem of limited resources. [159] Gleim #: 1.159 -- Source: IIA, adapted A means of limiting production delays caused by equipment breakdown and repair is to

A. B. C. D.

Schedule production based on capacity planning. Plan maintenance activity based on an analysis of equipment repair work orders. Pre-authorize equipment maintenance and overtime pay. Establish a preventive maintenance program for all production equipment. Answer (A) is incorrect because scheduling production based on capacity utilization ignores other important factors such as demands. Answer (B) is incorrect because budgeting maintenance department activities based on previous work orders will not prevent equipment breakdowns and repairs. Answer (C) is incorrect because standing authorizations of work orders and overtime will not address the problem posed. Answer (D) is correct. A preventive maintenance program will reduce equipment breakdowns and repairs.

[160] Gleim #: 1.160 -- Source: IIA, adapted To remove the effect of seasonal variation from a time series, original data should be

A. B. C. D.

Increased by the seasonal factor. Reduced by the seasonal factor. Multiplied by the seasonal factor. Divided by the seasonal factor. Answer (A) is incorrect because the original data should be divided by the seasonal factor, not increased. Answer (B) is incorrect because the original data should be divided by the seasonal factor, not reduced. Answer (C) is incorrect because the original data should be divided by the seasonal factor, not multiplied. Answer (D) is correct. Seasonal variations are common in many businesses. To remove the effect of seasonal variation from a time series, the original data (with the four trends) is divided by the seasonal norm.

[161] Gleim #: 1.161 -- Source: IIA, adapted A balanced scorecard is primarily concerned with

A. B. C. D.

Staff. Structure. Strategy. Systems.

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Answer (A) is incorrect because although a balanced scorecard should be developed with staff in mind, the primary aim is the alignment of performance measures with strategy. Answer (B) is incorrect because structure should be created after the scorecard has been developed to ensure that responsibilities, competencies and measures are appropriate to achieve the agreed-upon strategies. Answer (C) is correct. The scorecard is primarily a tool to assist the organization in describing and clarifying its strategy and then alignment of its performance measures to that strategy. Answer (D) is incorrect because systems are a means to achieving objectives that have been established after the development of the scorecard. [162] Gleim #: 1.162 -- Source: CIA 596 I-20 If a manufacturer has established a limit on the number of defects that are tolerable in the final assembly of its product, which of the following quality control procedures should be employed? I. II. III. IV. Inspect completed goods for compliance with established tolerances. Review sales returns for defects not detected during the final inspection process. Compare materials and machinery specifications with original product designs. Establish a quality circle that includes management and subordinates to discuss labor efficiency.

A. B. C. D.

I, III, and IV. II and III only. I, II, and III. III and IV only. Answer (A) is incorrect because establishing a quality circle is not a specific quality control procedure, although such discussions may lead to improved procedures. Answer (B) is incorrect because inspection is a necessary procedure. Answer (C) is correct. Quality control procedures may be categorized according to the nature of the costs incurred. An organization incurs appraisal costs to ensure product quality. These costs include the costs of inspection, testing, and statistical quality control programs. An organization also should investigate the causes of sales returns, which represent an external failure cost. Furthermore, the organization should incur certain prevention costs, e.g., by reviewing equipment design and materials requirements. Answer (D) is incorrect because establishing a quality circle is not a specific quality control procedure, although such discussions may lead to improved procedures.

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[Fact Pattern #12]

Candman Company is a wholesale distributor of candy. The company leases space in a public warehouse and is charged according to the square feet occupied. Candman has decided to employ the economic order quantity (EOQ) method to determine the optimum number of cases of candy to order. The company placed 2,400 orders the last year. Data for the high-activity month, the low-activity month, and the year for the purchasing and warehouse operations appear in the next column. The annual charges for the warehouse totaled $12,750 last year. In addition, the annual insurance and property taxes on the candy stored in the warehouse amounted to $1,500 and $2,250, respectively. The average monthly inventory last year was $75,000. [163] Gleim #: 2.1 -- Source: CMA 686 5-29

Long-term capital investments are expected to earn 12% after income taxes. Candman is subject to an effective income tax rate of 40%. High-Activity Low-Activity Month Month Annual (160 Orders) (100 Orders) Costs Purchasing Dept. Manager Clerks Supplies Warehouse Supervisor Rcvg. clerks Ship. clerks Totals $ 1,600 1,750 400 1,550 2,200 2,800 $10,300 $1,600 1,250 260 1,550 1,700 2,500 $8,860 $ 23,400 18,000 3,500 18,600 20,500 31,200 $115,200

(Refers to Fact Pattern #12) The incremental cost of placing an order that would be used in the EOQ model is

A. B. C. D.

$48 $35 $24 $19 Answer (A) is incorrect because $48 equals total annual cost divided by total orders from the previous year. Answer (B) is incorrect because $35 equals total annual cost minus the costs associated with the shipping clerks, divided by total orders from the previous year. Answer (C) is incorrect because $24 includes the costs associated with shipping. Answer (D) is correct. The incremental cost of additional orders equals the variable costs incurred in purchasing and receiving inventory (but not costs associated with shipping). Using the high-low method of analysis, these variable costs can be computed by determining the apparent variable costs for the two given levels of activity. For 160 orders, the relevant costs with a variable element include purchasing clerks, $1,750; supplies, $400; and receiving clerks, $2,200. The total is $4,350. For 100 orders, these costs are $1,250, $260, and $1,700, respectively, for a total of $3,210. As the number of orders increased by 60, the costs increased by $1,140. Consequently, the variable or incremental costs per order must have been $19 ($1,140 60 orders).

[164] Gleim #: 2.2 -- Source: CMA 686 5-30 (Refers to Fact Pattern #12) The annual carrying cost, stated as a percentage, that would be used in the EOQ model is

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A. B. C. D.

42% 37% 34% 22% Answer (A) is correct. The annual carrying costs are $12,750 for the warehouse, $1,500 for insurance, and $2,250 for property taxes. These costs total $16,500. In addition, the company desires a 12% after-tax return on investments. Because the tax rate is 40%, the 12% after-tax return equals a 20% before-tax return (12% 60%). A 20% return on the $75,000 average investment in inventory is $15,000. Hence, the total carrying cost is $31,500 ($16,500 + $15,000). This amount is 42% of the $75,000 investment in inventory. Answer (B) is incorrect because 37% does not consider insurance and property taxes. Answer (C) is incorrect because 34% is based on a 12% before-tax return. Answer (D) is incorrect because 22% equals carrying costs other than return on investment divided by average inventory.

[165] Gleim #: 2.3 -- Source: CIA 597 III-91 When the economic order quantity (EOQ) decision model is employed, the <List A> are being offset or balanced by the <List B>.

List A A. B. C. D. Ordering costs Purchase costs Purchase costs Ordering costs

List B Carrying costs Carrying costs Quality costs Stockout costs

Answer (A) is correct. The objective of the EOQ model is to find an optimal order quantity that balances carrying and ordering costs. Only variable costs should be considered. The EOQ is the point where the ordering cost and carrying cost curves intersect. It corresponds to the minimum point on the total inventory cost curve. Answer (B) is incorrect because purchase costs are not directly incorporated into the EOQ model. Answer (C) is incorrect because neither purchase costs nor quality costs are incorporated into the EOQ model. Answer (D) is incorrect because stockout costs are not directly incorporated into the EOQ model. [166] Gleim #: 2.4 -- Source: CMA 1290 4-9 The calculation of an economic order quantity (EOQ) considers

A. B. C. D.

The purchasing managers salary. A corporate charge for advertising expenses. The shipping costs to deliver the product to the customer. Capital costs. Answer (A) is incorrect because the purchasing managers salary is a fixed cost. The EOQ model includes variable costs only. Answer (B) is incorrect because advertising is not an ordering or carrying cost. Answer (C) is incorrect because the cost of shipping to customers is a selling expense. Answer (D) is correct. The determination of the economic order quantity balances the variable costs of ordering and carrying inventory. Factors in the equation include the cost of placing an order, unit carrying cost, and annual demand in units. Carrying costs include storage costs, handling costs, insurance, property taxes, obsolescence, and the opportunity cost of investing capital in inventory. Thus, the return on capital that is forgone when it is invested in inventory should be considered.

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[167] Gleim #: 2.5 -- Source: CMA 1294 4-8 A characteristic of the basic economic order quantity (EOQ) model is that it

A. B. C. D.

Is relatively insensitive to error. Should not be used when carrying costs are large in relation to procurement costs. Is used when product demand, lead-time, and ordering costs are uncertain. Should not be used in conjunction with computerized perpetual inventory systems. Answer (A) is correct. The basic EOQ model equals the square root of the quotient of (1) the product of twice the demand times the cost per order, (2) divided by the periodic carrying cost. Hence, the model is relatively insensitive to error. A given percentage error in a value results in a lower percentage change in the EOQ. Answer (B) is incorrect because the EOQ model can be used regardless of the relationship between carrying and holding costs. Answer (C) is incorrect because product demand and ordering costs must be known with some certainty. Answer (D) is incorrect because an EOQ model can be used with any type of system.

[168] Gleim #: 2.6 -- Source: CMA 1294 4-6 Companies that adopt just-in-time purchasing systems often experience

A. B. C. D.

An increase in carrying costs. A reduction in the number of suppliers. A greater need for inspection of goods as the goods arrive. Less need for linkage with a vendors computerized order entry system. Answer (A) is incorrect because carrying costs typically decline in JIT companies. Less inventory is on hand. Answer (B) is correct. The objective of JIT is to reduce carrying costs by eliminating inventories and increasing the deliveries made by suppliers. Ideally, shipments of raw materials are received just in time to be incorporated into the manufacturing process. The focus of quality control under JIT is the prevention of quality problems. Quality control is shifted to the supplier. JIT companies typically do not inspect incoming goods; the assumption is that receipts are of perfect quality. Suppliers are limited to those who guarantee perfect quality and prompt delivery. Answer (C) is incorrect because, in a JIT system, materials are delivered directly to the production line ready for insertion in the finished product. Answer (D) is incorrect because the need for communication with the vendor is greater. Orders and deliveries must be made on short notice, sometimes several times a day.

[169] Gleim #: 2.7 -- Source: CIA 597 III-94 A manufacturing company is attempting to implement a just-in-time (JIT) purchase policy system by negotiating with its primary suppliers to accept long-term purchase orders which result in more frequent deliveries of smaller quantities of raw materials. If the JIT purchase policy is successful in reducing the total inventory costs of the manufacturing company, which of the following combinations of cost changes would be most likely to occur?

Cost Category to Increase A. B. C. D. Purchasing costs Purchasing costs Quality costs Stockout costs

Cost Category to Decrease Stockout costs Quality costs Ordering costs Carrying costs

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Answer (A) is incorrect because the supplier may seek a concession on the selling price that will raise purchasing costs, but the manufacturing companys stockout costs will increase. Answer (B) is incorrect because the cost of quality is not necessarily affected by a JIT system. Answer (C) is incorrect because fewer purchase orders are processed by the manufacturer, so the ordering costs are likely to decrease. However, the cost of quality is not necessarily affected by a JIT system. Answer (D) is correct. The objective of a JIT system is to reduce carrying costs by eliminating inventories and increasing the deliveries made by suppliers. Ideally, shipments are received just in time to be incorporated into the manufacturing process. This system increases the risk of stockout costs because the inventory buffer is reduced or eliminated. [170] Gleim #: 2.8 -- Source: CMA 1288 5-22 Arnold Enterprises uses the EOQ model for inventory control. The company has an annual demand of 50,000 units for part number 191 and has computed an optimal lot size of 6,250 units. Per-unit carrying costs and stockout costs are $13 and $3, respectively. The following data have been gathered in an attempt to determine an appropriate safety stock level: Units Short Because of Excess Demand During the Lead Time Period 200 300 400 Number of Times Short in the Last 40 Reorder Cycles 6 12 6

The annual cost of establishing a 200-unit safety stock is expected to be

A. B. C. D.

$2,600 $4,040 $4,260 $5,200 Answer (A) is incorrect because $2,600 is the annual carrying cost of 200 units of safety stock. Answer (B) is correct. The annual cost consists of the carrying cost of the 200 units of safety stock at $13 each, or $2,600, plus the stockout costs incurred when 200 units are insufficient. The stockout cost per unit is $3. The excess demand has been 100 units (300 200) greater than the proposed safety stock 30% of the time (12 40). The cost per stockout was $300 ($3 100). Demand has exceeded the safety stock by 200 units (400 200) 15% of the time (6 40). The cost per stockout was $600 ($3 200). Given 30% and 15% probabilities of $300 and $600 stockout costs, respectively, the expected stockout cost for a 200-unit safety stock is $180 per inventory cycle [($300 30%) + ($600 15%)]. Given 8 cycles (50,000 units 6,250 EOQ), the annual cost of a 200-unit safety stock is therefore $4,040 [$2,600 + (8 $180)]. Answer (C) is incorrect because $4,260 is the annual cost of establishing a 300-unit safety stock. Answer (D) is incorrect because $5,200 is the annual cost of establishing a 400-unit safety stock.

[Fact Pattern #13] The diagram presented represents the economic order quantity (EOQ) model.

(Refer to Figure CIA3_02_14.)

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[171] Gleim #: 2.9 -- Source: CMA 1289 5-16 (Refers to Fact Pattern #13) Which line segment represents the reorder lead time?

A. B. C. D.

AB. AE. AF. BC. Answer (A) is incorrect because AB is the time between receipt of the last order and the placing of the next order. Answer (B) is incorrect because AE is the safety stock. Answer (C) is incorrect because AF represents the quantity of inventory that will be used during the reorder lead time. Answer (D) is correct. The quantity of inventory on hand is represented by the y axis and time by the x axis. The reorder lead time is represented by the line segment BC.

[172] Gleim #: 2.10 -- Source: CMA 1289 5-17 (Refers to Fact Pattern #13) Which line segment identifies the quantity of safety stock maintained?

A. B. C. D.

AB. AE. AC. BC. Answer (A) is incorrect because AB is the time between the receipt of the last order and the placing of the next order. Answer (B) is correct. Quantities of inventory are shown along the y axis. Safety stock is represented by the line AE. Answer (C) is incorrect because AC is the time to consume the EOQ. Answer (D) is incorrect because BC is the reorder lead time.

[173] Gleim #: 2.11 -- Source: CMA 1289 5-18 (Refers to Fact Pattern #13) Which line segment represents the length of time to consume the total quantity of materials ordered?

A. B. C. D.

DE. BC. AC. AE. Answer (A) is incorrect because DE represents the total inventory on hand just after an order has been received. Answer (B) is incorrect because BC is the reorder lead time. Answer (C) is correct. Time is shown along the x axis. The line segment AC depicts the time to consume an entire order (to reduce the inventory to the safety stock). Answer (D) is incorrect because AE is the safety stock.

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[174] Gleim #: 2.12 -- Source: CMA 692 4-23 Each stockout of a product sold by A.W. Inn Co. costs $1,750 per occurrence. The carrying cost per unit of inventory is $5 per year, and the company orders 1,500 units of product 24 times a year at a cost of $100 per order. The probability of a stockout at various levels of safety stock is

Units of Safety Stock 0 100 200 300 400

Probability of a Stockout .50 .30 .14 .05 .01

The optimal safety stock level for the company is

A. B. C. D.

0 units. 100 units. 300 units. 400 units. Answer (A) is incorrect because a safety stock of 0 units has a total expected cost of $21,000. Answer (B) is incorrect because a safety stock of 100 units has a total expected cost of $13,100. Answer (C) is incorrect because a safety stock of 300 units has a total expected cost of $3,600. Answer (D) is correct. The total expected cost of safety stock equals the sum of the expected annual stockout cost and the expected annual carrying cost. Annual expected stockout cost equals the cost per occurrence ($1,750), times the probability of a stockout per cycle, times the number of cycles (24). Annual expected carrying cost of a safety stock equals the unit carrying cost ($5) times the number of units. Hence, a safety stock of 400 units has the lowest total expected cost.

Units Held 0 100 200 300 400

Carrying Cost $ 0 500 1,000 1,500 2,000

Expected Stockout Cost Per Cycle $875.00 525.00 245.00 87.50 17.50

Expected Stockout Cost for 24 Cycles $21,000 12,600 5,880 2,100 420

Total Expected Cost $21,000 13,100 6,880 3,600 2,420

[Fact Pattern #14] The Huron Corporation purchases 60,000 headbands per year. The average purchase lead time is 20 working days. Maximum lead time is 27 working days. The corporation works 240 days per year. [175] Gleim #: 2.13 -- Source: CMA 1293 4-8 (Refers to Fact Pattern #14) Huron Corporation should carry safety stock of

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A. B. C. D.

5,000 units. 6,750 units. 1,750 units. 250 units. Answer (A) is incorrect because 5,000 units represents the quantity expected to be sold during the normal lead time. Answer (B) is incorrect because 6,750 units includes not only the safety stock but also the units expected to be sold during the normal lead time. Answer (C) is correct. Safety stock is defined as the amount of extra stock that is kept to guard against stockouts. It is the inventory level at the reorder point minus the expected usage during the lead time. Daily usage is 250 units (60,000 per year 240 days). Given a maximum lead time of 27 days and a normal lead time of 20 days, a safety stock for 7 days (27 20) should be maintained. Hence, safety stock is 1,750 units (7 250 units). Answer (D) is incorrect because 250 units is 1 days sales.

[176] Gleim #: 2.14 -- Source: CMA 1293 4-9 (Refers to Fact Pattern #14) Huron Corporation should reorder headbands when the quantity in inventory reaches

A. B. C. D.

5,000 units. 6,750 units. 1,750 units. 5,250 units. Answer (A) is incorrect because 5,000 units does not allow for safety stock. Answer (B) is correct. The reorder point is the quantity on hand when an order is placed. With a 20-day normal lead time, a 7-day safety stock, and usage of 250 units per day, an order should be placed when 27 days of inventory are on hand, a total of 6,750 units (27 250). Answer (C) is incorrect because 1,750 units covers only safety stock. Answer (D) is incorrect because 5,250 units includes only 1 day of safety stock.

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[Fact Pattern #15] Ryerson Computer Furniture, Inc. (RCF) manufactures a line of office computer chairs. The annual demand for the chairs is estimated to be 5,000 units. The annual cost to hold one unit in inventory is $10 per year, and the cost to initiate a production run is $1,000. There are no computer chairs on hand, and RCF has scheduled four equal production runs of computer chairs for the coming year, the first of which is to be run immediately. RCF has 250 business days per year, sales occur uniformly throughout the year, and production start-up is within one day. RCF is considering using the following formula for determining the economic order quantity (EOQ):

If:

A = cost to initiate a production run per purchase order D = annual unit demand K = cost of carrying one unit per year

[177] Gleim #: 2.15 -- Source: CMA 694 4-23 (Refers to Fact Pattern #15) The number of production runs per year of computer chairs that would minimize the sum of carrying and setup costs for the coming year is

A. B. C. D.

1 2 4 5

Answer (A) is incorrect because a single production run indicates an EOQ of 5,000 units. The carrying costs of $25,000 [$10 ($5,000 2)] would exceed the $1,000 of setup costs. Answer (B) is incorrect because two production runs correspond to an EOQ of 2,500 units and an average inventory of 1,250 units. The resulting $12,500 of carrying costs would exceed the $2,000 of setup costs. Answer (C) is incorrect because four production runs correspond to an EOQ of 1,250 units and an average inventory of 625 units. The resulting $6,250 of carrying costs would exceed the $4,000 of setup costs. Answer (D) is correct. The EOQ minimizes the sum of carrying and setup costs. The EOQ is the amount at which carrying costs are equal to setup costs. Thus, plugging the data into the EOQ formula results in the following:

Thus, if each lot consists of 1,000 units, five production runs per year are needed to meet the 5,000-unit demand. At this level, setup costs will total $5,000 (5 $1,000). Carrying costs will also equal $5,000 ($10 per unit carrying cost average inventory of 500 units). Accordingly, total costs are minimized at $10,000.

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[178] Gleim #: 2.16 -- Source: CMA 694 4-22 (Refers to Fact Pattern #15) If RCF does not maintain a safety stock, the estimated total carrying costs for the computer chairs for the coming year based on their current schedule is

A. B. C. D.

$4,000 $5,000 $6,250 $12,500 Answer (A) is incorrect because the cost of maintaining an average inventory of 625 units is $6,250. Answer (B) is incorrect because $5,000 is based upon an EOQ of 1,000 units and an average inventory of 500 units. Answer (C) is correct. Given four production runs and an annual demand of 5,000 units, each production run must generate 1,250 units. Inventory will total 1,250 units at the completion of each run but will decline to zero just prior to the next run. Thus, the average inventory is 625 units (1,250 2), and the total carrying cost is $6,250 ($10 625 units). Answer (D) is incorrect because $12,500 is based on the maximum inventory level.

[179] Gleim #: 2.17 -- Source: Publisher An organization must manage its flows of raw materials, components, finished goods, services, or information through intermediaries to ultimate consumers. These flows may occur across the functions in an organizations

A. B. C. D.

Supply chain. Value chain. Logistic chain. Integrated chain. Answer (A) is incorrect because the supply chain consists of the flows that may occur across the functions in an organizations value chain or separate organizations. Answer (B) is correct. The supply chain consists of flows from sources of (a) raw materials, (b) components, (c) finished goods, (d) services, or (e) information through intermediaries to ultimate consumers. These flows and the related activities may occur across the functions in an organizations value chain (R&D, design, production, marketing, distribution, and customer service). These flows and the related activities also may occur across separate organizations. Answer (C) is incorrect because logistics is a branch of military science. It addresses the procurement, maintenance, and transportation of military materials, facilities, and personnel. Answer (D) is incorrect because the phrase integrated chain is not a technical term.

[180] Gleim #: 2.18 -- Source: Publisher The bullwhip or whiplash effect on inventories begins when retailers face uncertain demand from consumers caused by randomness in buying habits. It can be avoided by

A. B. C. D.

The need to purchase or manufacture goods in cost-efficient batches. Changes in price that may encourage purchases in anticipation of future increases. Shortages that may lead to rationing by suppliers or manufacturers and hoarding by manufacturers or retailers. Sharing of information and coordination among the organizations in the supply chain.

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Answer (A) is incorrect because the need to purchase or manufacture goods in cost-efficient batches is a cause of the bullwhip or whiplash effect. Answer (B) is incorrect because purchases in anticipation of future price increases cause the bullwhip or whiplash effect. Answer (C) is incorrect because rationing by suppliers or manufacturers and hoarding by manufacturers or retailers cause the bullwhip or whiplash effect. Answer (D) is correct. Sharing information about sales, inventory, pricing, advertising campaigns, and sales forecasts by all functions and organizations in the supply chain moderates demand uncertainty for all parties. The desired results are: (a) minimization of inventories held by suppliers, manufacturers, and retailers; (b) avoidance of stockouts; (c) fewer rush orders; and (d) production as needed by retailers. [181] Gleim #: 2.19 -- Source: Publisher A desired result of the sharing of information by all functions and organizations in the supply chain is

A. B. C. D.

Fewer rush orders. Maximization of inventories held by suppliers, manufacturers, and retailers. Stockouts. Incompatibility of the information systems of the parties. Answer (A) is correct. Sharing information about sales, inventory, pricing, advertising campaigns, and sales forecasts by all functions and organizations in the supply chain moderates demand uncertainty for all parties. The desired results are: (a) minimization of inventories held by suppliers, manufacturers, and retailers; (b) avoidance of stockouts; (c) fewer rush orders; and (d) production as needed by retailers. Answer (B) is incorrect because minimization of inventories held by all parties in the supply chain is a desired result of sharing information. Answer (C) is incorrect because avoidance of stockouts is a desired result of sharing information. Answer (D) is incorrect because incompatibility of the information systems of the parties is a difficulty faced by supplychain management, not a desired result of sharing information.

[182] Gleim #: 2.20 -- Source: Publisher Which of the following are intermediaries between sellers and buyers? I. II. III. IV. Agent Broker Consignee Consumer

A. B. C. D.

I and II only. I and III only. I, II, and III only. I, II, III, and IV. Answer (A) is incorrect because a consignee is also an intermediary between sellers and buyers. Answer (B) is incorrect because a broker is an intermediary. Answer (C) is correct. A distribution channel is a series of interdependent marketing institutions that facilitate the transfer of a product from producer (seller) to consumer (buyer). Intermediaries include merchant middlemen, agents, brokers, consignees, and facilitating intermediaries. Answer (D) is incorrect because a consumer is a buyer, not an intermediary.

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[183] Gleim #: 2.21 -- Source: Publisher The channel structure in which producers, wholesalers, and retailers act as a unified system is a

A. B. C. D.

Horizontal distribution system. Vertical distribution system. Unilateral distribution system. Multichannel system. Answer (A) is incorrect because, in a horizontal distribution system, two or more companies at one level of the channel work together. Answer (B) is correct. In vertical distribution systems, producers, wholesalers, and retailers act as a unified system. Channel conflict is managed through common ownership, contractual relationships, or administration by one or a few dominant channel members. Horizontal distribution systems consist of two or more companies at one level of the channel working together to exploit new opportunities, such as the introduction of ATMs in supermarkets. The joint nature of horizontal distribution efforts is the tool for managing channel conflict. In a multichannel system, a single firm sets up two or more channels to reach one or more customer segments. Because such a system is managed by a single firm, channel conflicts can be evaluated and managed internally. Answer (C) is incorrect because a unilateral distribution system is not a channel structure. Answer (D) is incorrect because, in a multichannel system, a single firm sets up two or more channels.

[184] Gleim #: 2.22 -- Source: CIA 596 IV-78 Which one of the graphs depicts the demand curve for prestige goods?

A.

(Refer to Figure CIA3_02_17.)

B.

(Refer to Figure CIA3_02_18.)

C.

(Refer to Figure CIA3_02_19.)

D.

(Refer to Figure CIA3_02_20.)

Answer (A) is incorrect because this graph describes the familiar, negatively sloped relation between price charged and the resulting demand level for normal goods. Answer (B) is incorrect because the demand curve can be linear or curvilinear. Answer (C) is correct. Over some intermediate range of prices, the reaction to a price increase for prestige goods is an increase, not a decrease, in the quantity demanded. Within this range, the demand curve is upward sloping. The reason is that consumers interpret the higher price to indicate a better or more desirable product. Above some price level, the relation between price and quantity demanded will again become negatively sloped. Answer (D) is incorrect because this demand curve has the same basic shape as the demand curve for prestige goods, but it bends the wrong way. As prices increase, quantity demanded first falls and then rises in this graph.

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[185] Gleim #: 2.23 -- Source: CIA 1194 IV-78 Buyer-based pricing involves

A. B. C. D.

Adding a standard markup to the cost of the product. Determining the price at which the product will earn a target profit. Basing prices on the products perceived value. Basing prices on competitors prices. Answer (A) is incorrect because adding a standard markup to the cost of the product is cost-plus pricing. Answer (B) is incorrect because determining the price at which the product will earn a target profit is target profit pricing. Answer (C) is correct. Buyer-based pricing involves basing prices on the products perceived value rather than on the sellers cost. Nonprice variables in the marketing mix augment the perceived value. For example, a cup of coffee may have a higher price at an expensive restaurant than at a fast-food outlet. Answer (D) is incorrect because basing prices on competitors prices is going-rate pricing.

[186] Gleim #: 2.24 -- Source: CIA 1194 IV-79 Market-skimming pricing strategies could be appropriate when

A. B. C. D.

No buyers want the product at a high price. The costs of producing a small volume are low. Competitors can easily enter the market. The product is of poor quality. Answer (A) is incorrect because, if no buyers want the product at a high price, this marketing strategy is inappropriate. Answer (B) is correct. Market-skimming pricing is used when a new product is introduced at the highest price possible given the benefits of the product. For market skimming to work, the product must appear to be worth its price, the costs of producing a small volume cannot be so high that they eliminate the advantage of charging more, and competitors cannot enter the market and undercut the price. Answer (C) is incorrect because, if competitors can easily enter the market, they can undercut the price. Answer (D) is incorrect because the product quality and image must support a high price.

[187] Gleim #: 2.25 -- Source: CIA 595 IV-74 Which of the following pricing policies involves the selling company setting freight charges to customers at the actual average freight cost?

A. B. C. D.

Freight absorption pricing. Uniform delivered pricing. Zone pricing. FOB-origin pricing.

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Answer (A) is incorrect because, in freight absorption pricing, the selling company absorbs all or part of the actual freight charges. Customers are not charged actual delivery costs. Answer (B) is correct. In uniform delivered pricing, the company charges the same price, inclusive of shipping costs, to all customers regardless of their location. This price is the companys average actual freight cost. Thus, both nearby and distant customers are charged the same amount. This policy is easy to administer, permits the company to advertise one price nationwide, and facilitates marketing to faraway customers. Answer (C) is incorrect because, in zone pricing, differential freight charges are set for customers on the basis of their location. Customers are not charged actual average freight costs. Answer (D) is incorrect because, in FOB-origin pricing, each customer pays its actual freight costs. [188] Gleim #: 2.26 -- Source: CIA 1195 IV-75 Which of the following price adjustment strategies is designed to stabilize production for the selling firm?

A. B. C. D.

Cash discounts. Quantity discounts. Functional discounts. Seasonal discounts. Answer (A) is incorrect because cash discounts encourage prompt payment. Answer (B) is incorrect because quantity discounts encourage large volume purchases. Answer (C) is incorrect because functional or trade discounts are provided to channel members in return for the performance of certain functions, such as selling, storing, and record keeping. Answer (D) is correct. Seasonal discounts are designed to smooth production by the selling firm. For example, a ski manufacturer offers seasonal discounts to retailers in the spring and summer to encourage early ordering.

[189] Gleim #: 2.27 -- Source: CIA 1195 IV-76 In which product-mix pricing strategy is it appropriate for the seller to accept any price that exceeds the storage and delivery costs for the product?

A. B. C. D.

By-product pricing. Optional-product pricing. Captive-product pricing. Product-bundle pricing. Answer (A) is correct. A by-product is a product of relatively minor importance generated during the production of one or more other products. Its production entails no additional costs. Any amount received above the storage and delivery costs for a by-product allows the seller to reduce the main products price to make it more competitive. Answer (B) is incorrect because optional products are offered for sale along with the main product. They are unlikely to have a zero production cost, so the seller must receive a price above their storage and delivery costs. Answer (C) is incorrect because captive products must be used along with the main product, such as film for use with a camera. Sellers often make their profits on the captive products rather than on the main product, which is sold at a low price. The captive products therefore will be priced well above the storage and delivery costs. Answer (D) is incorrect because product bundles are combinations of products sold together at a reduced price, such as season tickets for a theater. Products are bundled to promote the sale of certain items that consumers might not otherwise purchase. The combined price of the bundle must be low enough to encourage consumers to buy the bundle but must recover production costs and provide some profit for the seller, so the price must exceed storage and delivery costs.

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[190] Gleim #: 2.28 -- Source: CMA 1296 4-6 Several surveys point out that most managers use full product costs, including unit fixed costs and unit variable costs, in developing cost-based pricing. Which one of the following is least associated with cost-based pricing?

A. B. C. D.

Price stability. Price justification. Target pricing. Fixed-cost recovery. Answer (A) is incorrect because full-cost pricing promotes price stability. It limits the ability to cut prices. Answer (B) is incorrect because full-cost pricing provides evidence that the company is not violating antitrust laws against predatory pricing. Answer (C) is correct. A target price is the expected market price of a product, given the companys knowledge of its customers and competitors. Hence, under target pricing, the sales price is known before the product is developed. Subtracting the unit target profit margin determines the long-term unit target cost. If cost-cutting measures do not permit the product to be made at or below the target cost, it will be abandoned. Answer (D) is incorrect because full-cost pricing has the advantage of recovering the full long-term costs of the product. In the long term, all costs are relevant.

[191] Gleim #: 2.29 -- Source: Publisher A U.S. sellers price in the U.S. market is below an appropriate measure of costs. Moreover, the seller has a reasonable prospect of recovering the resulting loss in the future through higher prices or a greater market share. Accordingly, the seller has engaged in

A. B. C. D.

Collusive pricing. Dumping. Predatory pricing. Price discrimination. Answer (A) is incorrect because collusive pricing involves a conspiracy to set higher prices. Answer (B) is incorrect because dumping is defined under U.S. law as sale by a non-U.S. company in the U.S. market of a product below its market value in the country where it was produced. Such sale is illegal if it threatens material injury to a U.S. industry. Answer (C) is correct. Predatory pricing is intentionally pricing below cost to eliminate competition and reduce supply. Federal statutes and many state laws prohibit the practice. The U.S. Supreme Court has held that pricing is predatory when two conditions are met: (1) the sellers price is below an appropriate measure of its costs, and (2) it has a reasonable prospect of recovering the resulting loss through higher prices or greater market share. Answer (D) is incorrect because price discrimination entails charging different prices to different customers for essentially the same product if the effect is to lessen competition substantially; to tend to create a monopoly; or to injure, destroy, or prevent competition.

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[192] Gleim #: 2.30 -- Source: Publisher Fulford Company applies the target pricing and costing approach. The following information about costs and revenues of Fulfords product are available for the year just ended:

Unit sales Unit selling price Cost of goods sold Value-chain operating costs excluding production

60,000 $400 $13,200,000 $7,920,000

Fulford plans to increase unit sales to 80,000 by reducing the products unit price to $320. If Fulford desires a unit target operating income of 12%, by what amount must it reduce the full cost per unit?

A. B. C. D.

$32.00 $38.40 $70.40 $80.00 Answer (A) is incorrect because $32.00 equals the current full cost per unit minus the new unit target price. Answer (B) is incorrect because $38.40 is the unit target operating income. Answer (C) is correct. Unit target operating income is $38.40 ($320 unit target price 12%). Hence, the unit target full cost is $281.60 ($320 $38.40). The current full cost per unit is $352.00 [($13,200,000 CGS + $7,920,000 other value chain operating costs) 60,000 units sold], so the necessary reduction in the full cost per unit is $70.40 ($352.00 $281.60). Answer (D) is incorrect because $80.00 equals the change in the unit price.

[193] Gleim #: 2.31 -- Source: Publisher A companys product has an expected 4-year life cycle from research, development, and design through its withdrawal from the market. Budgeted costs are Upstream costs (R&D, design) Manufacturing costs Downstream costs (marketing, distribution, customer service) After-purchase costs $2,000,000 3,000,000 1,200,000 1,000,000

The company plans to produce 200,000 units and price the product at 125% of the whole-life unit cost. Thus, the budgeted unit selling price is

A. B. C. D.

$15 $31 $36 $45

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Answer (A) is incorrect because $15 is the budgeted unit manufacturing cost. Answer (B) is incorrect because $31 is the budgeted unit life-cycle cost. Answer (C) is incorrect because $36 is the budgeted unit whole-life cost. Answer (D) is correct. Whole-life costs include after-purchase costs (operating, support, repair, and disposal) incurred by customers as well as life-cycle costs (R&D, design, manufacturing, marketing, distribution, and research). Hence, the budgeted unit whole-life cost is $36 [($2,000,000 + $3,000,000 + $1,200,000 + $1,000,000) 200,000 units], and the budgeted unit selling price is $45 ($36 125%). [194] Gleim #: 2.32 -- Source: IIA, adapted A manufacturing company produces plastic utensils for a particular segment at the lowest possible cost. The company is pursuing a cost

A. B. C. D.

Leadership strategy. Focus strategy. Differentiation strategy. Containment strategy. Answer (A) is incorrect because a cost leader is the lowest cost producer in the industry as a whole. Answer (B) is correct. A cost focus strategy aims at cost leadership in a particular segment, such as a regional market or a specialty product line. The rationale for a focus strategy is that the narrower market can be better served. Answer (C) is incorrect because cost differentiation aims at providing a product at different costs in different market segments. Answer (D) is incorrect because cost containment aims at controlling costs related to a particular product/market but not necessarily producing at the lowest possible cost.

[195] Gleim #: 2.33 -- Source: Publisher A runner-up firm in a market may choose a market-challenger strategy. Which general attack strategy adopted by a market challenger is directed at a gap in customer need fulfillment?

A. B. C. D.

Guerilla warfare. Bypass attack. Frontal attack. Flank attack. Answer (A) is incorrect because guerilla warfare consists of numerous small attacks designed to reduce the strength of the target, e.g., by ad campaigns, carefully chosen price decreases, and lawsuits. Such warfare ordinarily must be followed by a different (and stronger) type of attack if the challenge is to succeed. Answer (B) is incorrect because the bypass attack directs the assault against markets other than those where the competitive target is strong. It may involve diversification of products or geographic markets. It may also entail developing next-generation technology so as to move the competition to an arena where the challenger is in a stronger position. Answer (C) is incorrect because a frontal attack directly pits the firms products, prices, promotions, and methods of distribution against the targets. Answer (D) is correct. A flank attack may be directed at a geographic or segmental weakness of the target (an underserved market) or an unmet need (such as the desire for more healthful fast food). A flank attack succeeds when market segments shift. The result is a gap in need fulfillment that the attacker can convert into a strong position in a profitable segment.

[196] Gleim #: 2.34 -- Source: Publisher The dominant firm in a market pursues a market-leader strategy. This strategy may involve

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A. B. C. D.

Holding the market stable to avoid attracting new competitors. A flank defense to strengthen the firms brand. Sending market signals as a mobile defense. Innovations as an offensive strategy. Answer (A) is incorrect because, as the firm most likely to gain, the leader should attempt to increase total demand, for example, by attracting new users, encouraging new uses, and promoting increased use. Answer (B) is incorrect because a position defense strengthens the firms brand power. Answer (C) is incorrect because a preemptive defense anticipates an attack, such as by targeting particular competitors before they can launch assaults, flooding the market with products for every segment and niche, or by sending market signals indicating ways in which the leader intends to anticipate attacks. Answer (D) is correct. Constant innovation to improve products and services, control costs, and increase distribution effectiveness is the basis for a good offensive strategy. The leader must continuously improve the value offered to customers.

[197] Gleim #: 2.35 -- Source: IIA, adapted During the growth stage of a products life cycle

A. B. C. D.

The quality of products is poor. New product models and features are introduced. There is little difference between competing products. The quality of the products becomes more variable and products are less differentiated. Answer (A) is incorrect because poor product quality is evident during the introduction stage of the product life cycle. Answer (B) is correct. In the growth stage, sales and profits increase rapidly, cost per customer decreases, customers are early adopters, new competitors enter an expanding market, new product models and features are introduced, and promotion spending declines or remains stable. The firm enters new market segments and distribution channels and attempts to build brand loyalty and achieve the maximum share of the market. Thus, prices are set to penetrate the market, distribution channels are extended, and the mass market is targeted through advertising. The strategy is to advance by these means and by achieving economies of productive scale. Answer (C) is incorrect because competitors are most numerous and products become less differentiated during the maturity stage of the product life cycle. In this stage, imitators have entered the market and competitors have learned which technologies and features are successful. Answer (D) is incorrect because the quality of the products becomes more variable and products are less differentiated during the decline stage of the product life cycle.

[198] Gleim #: 2.36 -- Source: IIA, adapted In a products life cycle, the first symptom of the decline stage is a decline in the

A. B. C. D.

Firms inventory levels. Products sales. Products production cost. Products prices.

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Answer (A) is incorrect because a decline in the firms purchasesresulting in a decline in the firms inventory levelsis not the first symptom. It will occur only when production declines as a result of a drop in sales. Answer (B) is correct. The sales of most product types and brands eventually decrease permanently. This decline may be slow or rapid. This first symptom of the decline stage of a products life cycle triggers such other effects as price cutting, narrowing of the product line, and reduction in promotion budgets. Answer (C) is incorrect because a decline in production costs may be due to many factors, e.g., new plant technology or the increased availability of raw materials. Moreover, production costs may decrease in any stage of a products life cycle and not specifically in the decline stage. Answer (D) is incorrect because a change in prices is a marketing decision. It is an action that may be taken in the maturity stage to compete in the market. Moreover, a decrease in the products prices is a response to a permanent decline in sales. [199] Gleim #: 2.37 -- Source: IIA, adapted At the introduction stage of an innovative product, the profit growth is normally slow due to

A. B. C. D.

Expensive sales promotion. High competition. A mass market. Available alternatives. Answer (A) is correct. The introduction stage is characterized by slow sales growth and lack of profits because of the high expenses of promotion and selective distribution to generate awareness of the product and encourage customers to try it. Thus, the per-customer cost is high. Competitors are few, basic versions of the product are produced, and higherincome customers (innovators) are usually targeted. Cost-plus prices are charged. They may initially be high to permit cost recovery when unit sales are low. The strategy is to infiltrate the market, plan for financing to cope with losses, build supplier relations, increase production and marketing efforts, and plan for competition. Answer (B) is incorrect because, during the introduction stage, little competition exists. Competitors tend not to enter the market until they have greater assurance of profits. Answer (C) is incorrect because no mass market is available during the introduction stage. Answer (D) is incorrect because, by definition, not many alternatives are available during the introduction stage of an innovative product.

[200] Gleim #: 2.38 -- Source: IIA, adapted While auditing a marketing department, the internal auditor discovered that the product life cycle model was used to structure the marketing mix. Under such a philosophy, the price charged on a consistent basis for a specific product would probably be lowest during which life cycle stage?

A. B. C. D.

Introduction stage. Growth stage. Maturity stage. Decline stage.

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Answer (A) is incorrect because, during the introduction stage, pre-unit costs of production are high and little competition exists. Hence, prices are at their highest. Answer (B) is incorrect because, during the growth stage, prices will be lower than during the introduction stage, but not as low as during the maturity stage. In the growth stage, costs are dropping and competitors are being added, but costs are not at their minimum and competitors are not at their maximum. Answer (C) is correct. During the maturity stage, competition is at its greatest and costs are at their lowest. Moreover, firms are engaged in competitive price-cutting measures, resulting in some of the lowest prices seen during a products life cycle. Answer (D) is incorrect because, during the decline stage, price-cutting predominates as firms struggle to maintain sales volume in the face of a permanent decrease in demand. However, late in the decline stage, there are few competitors, so prices can be raised. In addition, pre-unit costs are on the rise because volume is declining, resulting in higher prices. [201] Gleim #: 2.39 -- Source: IIA, adapted While auditing a marketing department, the internal auditor discovered that the product life cycle model was used to structure the marketing mix. Under such a philosophy, the opportunity for cost reductions would be greatest in which stage of the life cycle?

A. B. C. D.

Introduction stage. Growth stage. Maturity stage. Decline stage. Answer (A) is incorrect because production volume is low during the introduction stage. Although costs are also high during this period, low volume reduces the opportunities for cost reductions. Answer (B) is correct. During the growth stage, the opportunity for cost reductions is at its maximum because production volume is increasing at a high rate. Thus, fixed costs are being spread over more units of production, and the benefits of the learning curve are being realized. Answer (C) is incorrect because production volume changes little during the maturity stage. The result is less opportunity for cost reductions. Answer (D) is incorrect because costs per unit typically rise during the decline stage as production volume declines.

[202] Gleim #: 2.40 -- Source: IIA, adapted While auditing a marketing department, the internal auditor discovered that the product life cycle model was used to structure the marketing mix. The manager has asked the auditor for advice about increasing advertising of various products. During which stage of the life cycle would it be appropriate to advertise that the companys product is the lowest price and best quality of all competitors?

A. B. C. D.

Introduction stage. Growth stage. Maturity stage. Decline stage.

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Answer (A) is incorrect because few competitors exist during the introduction stage, and quality is sometimes poor. Answer (B) is incorrect because buyers are less concerned with price and quality during the growth stage than in the maturity stage. Answer (C) is correct. The maturity stage is the ideal time for advertising lower prices and superior quality because this is the period during a products life when competition is greatest. Due to the availability of many alternatives or substitutes, a firm has reasons to set itself apart. Because price and quality are both concerns of customers during the maturity stage, it is ideal for the firm to differentiate its product by advertising low prices and higher quality. Answer (D) is incorrect because few competitors exist during the decline stage. Moreover, prices may rise late in the decline stage for the remaining firms as per-unit costs increase. [203] Gleim #: 2.41 -- Source: Publisher Gray market activity is in essence a form of arbitrage. To prevent this activity by their distributors, multinational firms I. Raise prices charged to lower-cost distributors. II. Police their distributors. III. Change the product.

A. B. C. D.

I only. I and II only. II and III only. I, II, and III. Answer (A) is incorrect because multinational firms also police their distributors and change the product to prevent gray market activity. Answer (B) is incorrect because multinational firms also change the product to prevent gray market activity. Answer (C) is incorrect because multinational firms also raise prices charged to lower-cost distributors to prevent gray market activity. Answer (D) is correct. In a gray market, products imported from one country to another are sold by persons trying to make a profit from the difference in retail prices between the two countries. These activities clearly lower the profits in some markets of the multinational firm that was the initial seller. One response is to monitor the practices of distributors and retaliate if necessary. A second response is to charge higher prices to the low-cost distributors to reduce their incentives to participate in a gray market. A third response is to differentiate products sold in different countries, e.g., by adapting the product or offering distinct service features.

[204] Gleim #: 2.42 -- Source: Publisher A firm buys like-new computer equipment from bankrupt companies and resells it in foreign markets at prices significantly below those charged by competitors. The firm is

A. B. C. D.

Engaged in dumping. Engaged in price discrimination. Operating in a gray market. Operating in a black market.

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Answer (A) is incorrect because dumping is sale below cost or at less than the price charged in the home market. Answer (B) is incorrect because price discrimination involves illegally selling the same products at different prices to different customers. Answer (C) is correct. In a gray market, products imported from one country to another are sold by persons trying to make a profit from the difference in retail prices between the two countries. In essence, the seller firm in this case was exploiting a price difference between markets. Answer (D) is incorrect because black market operations are illegal. [205] Gleim #: 2.43 -- Source: Publisher A firm ships its product to a foreign subsidiary and charges a price that may increase import duties but lower the income taxes paid by the subsidiary. The most likely reason for these effects is that the

A. B. C. D.

Price is an arms-length price. Price is a cost-plus price. Transfer price is too low. Transfer price is too high. Answer (A) is incorrect because an arms-length price is what a competitor would charge in that market. Answer (B) is incorrect because a cost-plus price does not necessarily trigger higher import duties. Answer (C) is incorrect because, if the transfer price is too low, import duties would be lower and taxes would be higher. Answer (D) is correct. A transfer price is the price charged by one subunit of a firm to another. When the subsidiarybuyer is in a foreign country, the higher the transfer, the higher the potential tariffs. However, the tax levied on a subsequent sale by the subsidiary will be lower because of its higher acquisition cost.

[206] Gleim #: 2.44 -- Source: Publisher A global firm establishes a cost-based price for its product in each country. The most likely negative outcome is that this pricing strategy will

A. B. C. D.

Set too high a price in countries where the firms costs are high. Overprice the product in some markets and underprice it in others. Create a gray market. Result in dumping. Answer (A) is correct. A firm may set a cost-based price in each market with a standard markup. In a region or country where costs are high, this strategy may result in prices that are too high to be competitive within the local market. Answer (B) is incorrect because a uniform pricing policy may overprice the product in some markets and underprice it in others. Answer (C) is incorrect because charging what consumers can afford in each country may create a gray market. Answer (D) is incorrect because dumping often entails charging a below-cost price.

[207] Gleim #: 2.45 -- Source: Publisher A firm sells its product in a foreign market for a much higher price than in its home market. The reason is most likely

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A. B. C. D.

Price elasticity of demand. Dumping. Gray market activity. Price escalation. Answer (A) is incorrect because price elasticity of demand is the relationship of total revenue to a change in price. If demand is price elastic, a price increase results in lower revenue. Answer (B) is incorrect because dumping is sale at a price below cost or below the price in the home country. Answer (C) is incorrect because In a gray market, products imported from one country to another are sold by persons trying to make a profit from the difference in retail prices between the two countries. Answer (D) is correct. Price escalation is caused by an accumulation of additional costs, e.g., currency fluctuations; transportation expenses; profits earned by importers, wholesalers, and retailers; and import duties.

[208] Gleim #: 2.46 -- Source: CMA 696 1-20 The protected group under the Age Discrimination in Employment Act of 1967, as amended, is defined as anyone in which age group?

A. B. C. D.

35 through 60. 40 through 75. 40 and older. 45 and older. Answer (A) is incorrect because the act provides protection for individuals who are aged 40 and older. Answer (B) is incorrect because the act provides protection for individuals who are aged 40 and older. Answer (C) is correct. The Age Discrimination in Employment Act is designed to protect individuals aged 40 and older from employment discrimination. The act has been amended to eliminate the mandatory retirement age. However, certain managerial employees are not protected by this amendment. Answer (D) is incorrect because the act provides protection for individuals who are aged 40 and older.

[209] Gleim #: 2.47 -- Source: Publisher Evaluating performance is not done to

A. B. C. D.

Determine the amount of nondiscriminatory benefits that each employee deserves. Assess the available human resources of the firm. Motivate the employees. Determine which employees deserve salary increases. Answer (A) is correct. There are many reasons for evaluating performance. Evaluations reinforce accomplishments, help in assessing employee strengths and weaknesses, provide motivation, assist in employee development, permit the organization to assess its human resource needs, and serve as a basis for wage increases. Nondiscriminatory benefits are given to everyone in the organization in equal amounts regardless of title, pay, or achievement of objectives. Answer (B) is incorrect because it is a purpose of a performance evaluation. Answer (C) is incorrect because it is a purpose of a performance evaluation. Answer (D) is incorrect because it is a purpose of a performance evaluation.

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[210] Gleim #: 2.48 -- Source: Publisher When a manager generalizes from the evaluation of one or a few traits to the employees total performance, (s)he has made

A. B. C. D.

A judgmental evaluation. An evaluation subject to the halo effect. A projection. An objective evaluation. Answer (A) is incorrect because a judgmental evaluation is based on nonverifiable, subjective criteria. Answer (B) is correct. 1. The halo effect occurs when the appraiser judges one or a few employee traits and carries over this judgment to the evaluation of the employees other traits. 2. The converse of the halo effect is the horn effect. It occurs when the manager allows one negative trait to influence the evaluation of other traits. Answer (C) is incorrect because projection is the process of attributing ones own traits to another person. Answer (D) is incorrect because an objective evaluation uses verifiable, often quantitative criteria.

[211] Gleim #: 2.49 -- Source: CIA 596 II-33 A manager discovers by chance that a newly hired employee has strong beliefs that are very different from the managers and from those of most of the other employees. The managers best course of action would be to

A. B. C. D.

Facilitate the reassignment of the new hire as quickly as possible before this situation becomes disruptive. Ask the rest of the team for their reaction and act according to the group consensus. Take no action unless the new hires behavior is likely to cause harm to the organization. Try to counsel the new hire into more reasonable beliefs. Answer (A) is incorrect because personal beliefs alone are not an appropriate basis for managerial action. Answer (B) is incorrect because personal beliefs alone are not an appropriate basis for managerial action. Answer (C) is correct. The only legitimate grounds on which the supervisor may take action is the employees behavior. Personal beliefs, such as those on religious and political matters, cannot be the basis of personnel actions. Discrimination on the basis of personal beliefs could expose the organization to legal action. Answer (D) is incorrect because personal beliefs alone are not an appropriate basis for managerial action.

[212] Gleim #: 2.50 -- Source: Publisher A company allows each of its departments to develop its own system for evaluating performance. Linda Ward, the personnel director, should communicate appraisal information to a new employee by

A. B. C. D.

Presenting anything that is pertinent to the listeners situation. Providing an overview of all systems within the company. Describing how her own performance is evaluated. Discussing each departments evaluation system in detail.

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Answer (A) is correct. The personnel director should tailor the discussion to the listener by describing how the employees department evaluates performance and what is expected of him/her. The director should also obtain feedback from the employee to determine if everything is clearly understood. Answer (B) is incorrect because discussing information that is irrelevant to the new employees appraisal information would confuse the new employee. Answer (C) is incorrect because discussing information that is irrelevant to the new employees appraisal information would confuse the new employee. Answer (D) is incorrect because discussing information that is irrelevant to the new employees appraisal information would confuse the new employee. [213] Gleim #: 2.51 -- Source: Publisher A disadvantage of separating performance evaluations from wage-increase decisions is that

A. B. C. D.

Not enough emphasis is placed on short-run performance. Financial rewards may lose their motivational effect. Employees may not be motivated by good appraisals. The employees performance evaluation does not consider the financial status of the company overall. Answer (A) is incorrect because an advantage of separating appraisals from wage increases is that more emphasis is placed on long-term objectives and goals. Answer (B) is incorrect because this separation does not deprive money of its motivational power, but it does emphasize other rewards, such as feelings of achievement and the recognition of superiors. Answer (C) is correct. The employee may not be motivated immediately by a good appraisal because of the delay in receipt of any monetary reward. The evaluation may also not be taken as seriously by the employee if compensation is not correlated with performance. Answer (D) is incorrect because an advantage of separating performance evaluations from wage-increase decisions is that the employees good performance can be separated from the overall companys bad financial performance.

[214] Gleim #: 2.52 -- Source: Publisher A company that wishes to improve its rate of retention of its experienced employees might

A. B. C. D.

Abolish its hire-from-within policy. Improve its fringe benefit package. Initiate job simplification programs. Set a mandatory retirement age. Answer (A) is incorrect because reduced opportunity for advancement may motivate employees to find jobs elsewhere. Answer (B) is correct. Fringe benefits (e.g., pensions and profit-sharing plans) may be contingent on duration of employment. Accordingly, they motivate employees to remain with the company. Answer (C) is incorrect because job simplification may result in boredom, lessened job satisfaction, and a higher turnover rate. Answer (D) is incorrect because abolition of a mandatory retirement age would be more appropriate.

[215] Gleim #: 2.53 -- Source: Publisher A company that formerly paid certain management employees on a salary plus commission basis decided to compensate a test group solely with commissions. Performance of these employees declined. The most likely explanation for this result is that

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A. B. C. D.

The employee received special attention. Compensation was a motivational factor. Compensation was not a hygiene factor. Increased concerns about security made the employees risk averse. Answer (A) is incorrect because the famous Hawthorne studies suggest that the employees knowledge of their special status would improve their output. Answer (B) is incorrect because Herzberg defines a motivational factor as one whose absence will not diminish performance but whose presence will be a motivator. Answer (C) is incorrect because a performance decline followed a reduction in the security of compensation; hence, money was probably a hygiene (maintenance) factor according to Herzbergs two-factor theory of motivation. Answer (D) is correct. A straight salary with commissions rewarded increased efforts while providing greater security and a reduction in anxiety. Satisfaction of the need for security may have permitted the employees to adopt promising and profitable but more risky strategies. Since people concerned about security needs tend to be risk averse, the change in compensation method probably caused the performance decline.

[216] Gleim #: 2.54 -- Source: CIA 1195 III-22 The human resource department of an organization observed that accounting staff turnover was unusually high. Exit interviews indicated that the accounting department work schedule was highly restrictive for accountants who had young children. To improve the retention of skilled employees in the accounting department, the best solution would be to

A. B. C. D.

Implement a program of job rotation within the accounting department. Promote job enlargement for the positions experiencing the greatest turnover. Provide job sharing and flextime opportunities for accounting department employees. Enrich the jobs of accounting department employees. Answer (A) is incorrect because job rotation would not adequately address the scheduling issue. Answer (B) is incorrect because job enlargement would not adequately address the scheduling issue. Answer (C) is correct. Job sharing and flextime allow employees to adjust their work schedules and hours to better achieve personal objectives. These programs can increase worker loyalty and motivation. Answer (D) is incorrect because job enrichment would not adequately address the scheduling issue.

[217] Gleim #: 2.55 -- Source: Publisher The factor that would not contribute to retention of experienced employees would be

A. B. C. D.

Initiation of job enrichment programs. Adherence to federal regulations regarding sex discrimination in paying and promoting workers. Paying new employees more than older ones. Adoption of flextime rules.

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Answer (A) is incorrect because a more intrinsically satisfying job will improve the retention rate. Answer (B) is incorrect because employees subject to discrimination may be strongly motivated to find other jobs. Answer (C) is correct. When old employees discover that newcomers are being hired at higher salaries, the group hired first will be unhappy, feeling that their greater experience should warrant greater reward. In the short run, the newcomers will be satisfied. But it is possible that next years newcomers will be hired at still higher salaries, contributing to the overall dissatisfaction. Thus, such a policy will provide incentives for experienced workers to leave the company. Answer (D) is incorrect because greater freedom in determining his/her hours may enable a worker to remain with the company when other responsibilities (e.g., child care) might have compelled him/her to leave. [218] Gleim #: 2.56 -- Source: Publisher The value of retaining employees is determined by

A. B. C. D.

Human asset accounting. Financial accounting. Cost accounting. Human resource planning. Answer (A) is correct. Human resource or human asset accounting attempts to measure the value, and the changes in value, of the organizations investment in human assets. Although this asset is enormously valuable (sometimes estimated at two or three times the annual payroll), it is not shown in balance sheets or accounted for in earnings statements. One experimental measurement approach is a sort of present value of human resources. Another is a cost approach, with dollar investments (training, customer goodwill, etc.) offset by reductions (e.g., retirement). Answer (B) is incorrect because this traditional accounting method does not value the organizations human assets. Answer (C) is incorrect because this traditional accounting method does not value the organizations human assets. Answer (D) is incorrect because it merely audits the skills of the current employees and forecasts needs.

[219] Gleim #: 2.57 -- Source: Publisher An employee with a good background and years of experience earns a salary at the top of his/her range. Under the companys compensation program, the employee must earn a promotion in order to increase his/her salary above the usual annual increase. Which of the following is most likely to be an effect on his/her behavior?

A. B. C. D.

The employee may refuse new duties or tasks. The employee may become less productive. The employee may not be motivated to improve performance. The employee may seek a position with another company. Answer (A) is incorrect because this behavior would undermine the employees chance for a promotion. Answer (B) is incorrect because this behavior would undermine the employees chance for a promotion. Answer (C) is incorrect because this behavior would undermine the employees chance for a promotion. Answer (D) is correct. When an employee can earn a desired salary increase only through a promotion, (s)he is likely to be motivated to perform better. If this does not result in a promotion, (s)he will probably look for another job.

[220] Gleim #: 2.58 -- Source: Publisher A companys compensation program does not allow for salary increases based on above-average performance after an employee reaches the top of a positions salary range. It also pays some employees higher salaries because of their educational qualifications. This company could improve the program by

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A. B. C. D.

Allowing each manager to set up his/her own system of salary increases. Providing only monetary compensation. Developing a system that equates years of experience with education. Decreasing the annual percentage increase in each salary range. Answer (A) is incorrect because the company should administer a uniform system of salary increases. Answer (B) is incorrect because the company could improve its system if it provided other compensation, such as assisting with an employees tuition or recognizing an employee who has given many years of service. Answer (C) is correct. A company with a compensation program that stops rewarding above-average performance at the top of each salary range and rewards education with higher compensation could improve the system in several ways. These include starting a bonus program for above-average performance, refusing to hire a person at the top of a salary range unless (s)he will be promoted quickly, and equating experience and education so that employees are treated fairly. Answer (D) is incorrect because the company would please all employees by increasing this percentage.

[221] Gleim #: 2.59 -- Source: Publisher Which of the following methods of employee evaluation is best used in a situation where employees are heavily involved in teamwork?

A. B. C. D.

360-degree performance appraisal. Attribution method. Critical incident technique. Behaviorally anchored rating scales (BARS). Answer (A) is correct. The 360-degree performance appraisal is a model for employee assessment in the age of teamwork. It is based on giving workers feedback from peers, customers, supervisors, and those who work for the employee. Feedback is typically provided anonymously and is usually subjective. Answer (B) is incorrect because this is a nonsense term. Answer (C) is incorrect because the critical incident technique is based on having a list of critical aspects of a job against which to compare the employees performance; it would usually not be effective in a team situation. Answer (D) is incorrect because BARS is based on specific job-related behaviors.

[222] Gleim #: 2.60 -- Source: Publisher If a supervisor fails to give an employee a negative evaluation because of fear of damaging a good working relationship, this is known as the

A. B. C. D.

Leniency error. Recency effect. Halo effect. Contrast error.

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Answer (A) is correct. A leniency error is when a manager fails to give a negative evaluation because of fear of damaging a good working relationship with an employee. Answer (B) is incorrect because the recency effect means that the employees most recent behavior overshadows overall performance. Answer (C) is incorrect because the halo effect means the managers judgment on one positive trait affects the rating on other traits. Answer (D) is incorrect because a contrast error is the tendency to rate people relative to other people, without consideration of performance standards. [223] Gleim #: 2.61 -- Source: CIA 591 III-11 During an audit of the personnel function, it was noted that numerous questions were asked of potential hirees. Which of the following questions would normally be appropriate when interviewing an inexperienced person applying for an entry-level internal auditing position?

A. B. C. D.

How have you kept up your internal auditing education? What kind of reports have you written in previous jobs? What are your career goals? What is your marital status? Answer (A) is incorrect because the inexperienced applicant may have just finished his/her education. Thus, continuing education may not be relevant. Answer (B) is incorrect because the applicant is inexperienced and thus may not have written reports in previous jobs. Answer (C) is correct. Sawyers Internal Auditing (IIA, 1988. p. 791) suggests the following questions for inexperienced candidates:

What is your concept of internal auditing? How did you hear about it? Why do you think youd like it? What kinds of assignments would you like best? What are your outside interests? What are your personal goals? Answer (D) is incorrect because federal law prohibits asking about marital status. [224] Gleim #: 2.62 -- Source: CIA 1192 III-10 When faced with the problem of filling a newly created or recently vacated executive position, organizations must decide whether to promote from within or to hire an outsider. One of the disadvantages of promoting from within is that

A. B. C. D.

Internal promotions can have negative motivational effect on the employees of the firm. Internal promotions are more expensive to the organization than hiring an outsider. It is difficult to identify proven performers among internal candidates. Hiring an insider leads to the possibility of social inbreeding within the firm.

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Answer (A) is incorrect because internal promotions usually lead to increased motivation among employees. Answer (B) is incorrect because internal promotions are less expensive. The firm can avoid the expenses associated with an executive search and certain training costs. Answer (C) is incorrect because it is more difficult to identify proven performers from among outside candidates than internal candidates. Answer (D) is correct. Hiring an internal candidate can lead to social inbreeding. Many firms look to external candidates for certain jobs because they bring a fresh perspective to the organizations problems and may have more up-to-date training or education. [225] Gleim #: 2.63 -- Source: CIA 597 IV-80 The airlines have been leaders in the use of technology. Customers can make reservations either with an airline or through a travel agency. In this situation, a travel agency is classified as which type of distribution channel?

A. B. C. D.

An intermediary. A jobber. A distributor. A facilitating agent. Answer (A) is correct. Marketing intermediaries assist companies in promoting, selling, and distributing their goods and services to ultimate consumers. For example, travel agents access an airlines computerized reservation system and make reservations for their customers without ever taking title to the ticket. Answer (B) is incorrect because jobbers buy from manufacturers, then resell the products. Answer (C) is incorrect because distributors, or wholesalers, usually have selective or exclusive distribution rights. Answer (D) is incorrect because facilitating agents assist in functions other than buying, selling, or transferring title.

[226] Gleim #: 2.64 -- Source: CIA 595 III-32 Just-in-time (JIT) inventory systems have been adopted by large manufacturers to minimize the carrying costs of inventories. Identify the primary vulnerability of JIT systems.

A. B. C. D.

Computer resources. Materials supply contracts. Work stoppages. Implementation time. Answer (A) is incorrect because JIT systems can require significant computer resources, but they can also be maintained manually. Answer (B) is incorrect because contracts may have to be renegotiated with strict delivery and quality specifications, but these changes usually occur over extended periods. Answer (C) is correct. JIT minimizes inventory by relying on coordination with suppliers to provide deliveries when they are needed for production. Consequently, work stoppages at suppliers or transportation disruptions can cause almost immediate work stoppages at the manufacturer plant. Answer (D) is incorrect because JIT can be implemented over an extended period or a shorter time frame depending on the manufacturers immediate needs.

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[227] Gleim #: 2.65 -- Source: CIA 596 III-98 A company manufactures banana hooks for retail sale. The bill of material for this item and the parts inventory for each material required are as follows: Bill of Materials Raw Material Wooden neck Wooden base Swag hook Wood screws Foot pads Quantity Required 1 1 1 2 4 On Hand 0 0 300 400 1,000

An incoming order calls for delivery of 2,000 banana hooks in 2 weeks. The company has 200 finished banana hooks in current inventory. If no safety stocks are required for inventory, what are the companys net requirements for swag hooks and screws needed to fill this order?

Swag Hooks A. B. C. D. 1,500 1,500 1,700 1,800

Wood Screws 1,400 3,200 3,600 3,600

Answer (A) is incorrect because 1,400 wood screws assumes that one wood screw is used per banana hook. Answer (B) is correct. The company needs 1,800 banana hooks (2,000 200) and therefore 1,800 swag hooks (1 1,800) and 3,600 wood screws (2 1,800). Given that 300 swag hooks and 400 wood screws are on hand, the company must obtain 1,500 swag hooks (1,800 300) and 3,200 wood screws (3,600 400). Answer (C) is incorrect because 1,700 swag hooks and 3,600 wood screws would be needed if no banana hooks were in current inventory. Answer (D) is incorrect because 1,800 swag hooks would be needed if no swag hooks were in current inventory. Also, 3,600 wood screws would be needed if no banana hooks were in current inventory. [228] Gleim #: 2.66 -- Source: CIA 594 III-66 The purpose of the economic order quantity model is to:

A. B. C. D.

Minimize the safety stock. Minimize the sum of the order costs and the holding costs. Minimize the inventory quantities. Minimize the sum of the demand costs and the backlog costs. Answer (A) is incorrect because the basic EOQ model does not include safety stock. Answer (B) is correct. The purpose of the EOQ model is to minimize the sum of inventory order costs and holding costs. The EOQ equals the square root of: twice the annual demand multiplied by the variable cost per order, divided by the unit periodic holding cost. Answer (C) is incorrect because, in the EOQ model, costs, not quantities, are to be minimized. Answer (D) is incorrect because quantity demanded is a variable in the model, but order costs, not demand costs, are relevant. Backlogs are customer orders that cannot be filled immediately because of stockouts. Backlog costs are not quantified in the model.

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[229] Gleim #: 2.67 -- Source: CIA 593 III-70 Which of the following is used in determining the economic order quantity (EOQ)?

A. B. C. D.

Regression analysis. Calculus. Markov process. Queuing theory. Answer (A) is incorrect because regression analysis is used to fit a linear trend line to a dependent variable based on one or more independent variables. Answer (B) is correct. The primary business application of differential calculus is to identify the maxima or minima of curvilinear functions. In business and economics, these are the points of revenue or profit maximization (maxima) or cost minimization (minima). The EOQ results from differentiating the total cost with regard to order quantity. Answer (C) is incorrect because Markov process models are used to study the evolution of certain systems over repeated trials. Answer (D) is incorrect because queuing theory is a waiting-line technique used to balance desirable service levels against the cost of providing more service.

[230] Gleim #: 2.68 -- Source: CIA 590 III-45 The EOQ (economic order quantity) model calculates the cost-minimizing quantity of a product to order, based on a constant annual demand, carrying costs per unit per annum, and cost per order. For example, the EOQ is approximately 447 units if the annual demand is 10,000 units, carrying costs are 1 currency unit per item per annum, and the cost of placing an order is $10. What will the EOQ be if the demand falls to 5,000 units per annum and the carrying and ordering costs remain at $1 and $10, respectively?

A. B. C. D.

316 447 483 500 Answer (A) is correct. The EOQ formula is

If: D is the demand, or number of units used per year. A is the cost of placing one order. K is the cost of carrying one item for 1 year.

Answer (B) is incorrect because 447 is the EOQ when demand is 10,000 units per year. Answer (C) is incorrect because 483 results when annual demand is 11,664 units. Answer (D) is incorrect because 500 results when annual demand is 12,500 units.

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[231] Gleim #: 2.69 -- Source: CIA 1190 III-42 A company stocks, maintains, and distributes inventory. The company decides to add to the safety stock and expedite delivery for several product lines on a trial basis. For the selected product lines the company will experience

A. B. C. D.

An increase in some costs but no change in the service level. A change in the service level. An increase in ordering, carrying, and delivery costs. A decrease in ordering, carrying, and delivery costs. Answer (A) is incorrect because service will improve. Answer (B) is correct. Safety stocks are amounts held in excess of forecasted demand to avoid the losses associated with stockouts. Holding safety stocks improves the level of service to customers at the expense of increased holding costs. Answer (C) is incorrect because ordering costs will not increase. The fixed costs of the ordering department will be unaffected. Also, the departments variable costs should not change because the EOQ will be the same. However, in the first year, an additional order may be necessary to increase the safety stock. Answer (D) is incorrect because delivery will increase under the new expedited delivery policy. Moreover, increasing the safety stock increases carrying costs.

[232] Gleim #: 2.70 -- Source: CIA 1193 IV-26 Which of the following inventory items would be the most frequently reviewed in an ABC inventory control system?

A. B. C. D.

Expensive, frequently used, high stock-out cost items with short lead times. Expensive, frequently used, low stock-out cost items with long lead times. Inexpensive, frequently used, high stock-out cost items with long lead times. Expensive, frequently used, high stock-out cost items with long lead times. Answer (A) is incorrect because long, not short, lead times prompt a more frequent review. Answer (B) is incorrect because high, not low, stockout costs prompt a more frequent review. Answer (C) is incorrect because expensive, not inexpensive, items prompt a more frequent review. Answer (D) is correct. The ABC system is a method for controlling inventories that divides inventory items into three groups:

Group A -- high-dollar value items, which account for a small portion (perhaps 10%) of the total inventory usage Group B -medium-dollar value items, which may account for about 20% of the total inventory items low-dollar value items, which account for the remaining 70% of sales or usage

Group C --

The ABC system permits the proper degree of managerial control to be identified and exercised over each group. Group A items are reviewed on a regular basis. Group B items may not have to be reviewed as often as group A items, but more often than group C items. For group C, extensive use of models and records is not cost effective. It is cheaper to order large quantities infrequently. The ABC method therefore reduces the safety-stock investment because high-value items are frequently monitored and medium-value items are monitored more often than inexpensive items. Frequent review can prevent stockouts and decrease inventory levels, and the cost of such review is minimized if it is limited to high- or medium-value items.

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[233] Gleim #: 2.71 -- Source: CIA 1193 IV-25 The company uses a planning system that focuses first on the amount and timing of finished goods demanded and then determines the derived demand for raw material, components, and subassemblies at each of the prior stages of production. This system is referred to as

A. B. C. D.

Economic order quantity. Materials requirements planning. Linear programming. Just-in-time purchasing. Answer (A) is incorrect because the economic order quantity is a decision model that focuses on the trade-off between carrying and ordering costs. Answer (B) is correct. Materials requirements planning (MRP) is usually a computer-based information system designed to plan and control raw materials used in a production setting. It assumes that estimated demand for materials is reasonably accurate and that suppliers can deliver based upon this accurate schedule. It is crucial that delivery delays be avoided because, under MRP, production delays are almost unavoidable if the materials are not on hand. An MRP system uses a parts list, often called a bill of materials, and lead times for each type of material to obtain materials just as they are needed for planned production. Answer (C) is incorrect because linear programming is a decision model concerned with allocating scarce resources to maximize profit or minimize costs. Answer (D) is incorrect because just-in-time purchasing involves the purchase of goods such that delivery immediately precedes demand or use.

[234] Gleim #: 2.72 -- Source: CIA 592 III-62 An inventory planning method that minimizes inventories by arranging to have raw materials and subcomponents arrive immediately preceding their use is called

A. B. C. D.

A safety stock planning system. An economic order quantity model. A just-in-time inventory system. A master budgeting system. Answer (A) is incorrect because safety stock is the inventory maintained in order to reduce the number of stockouts resulting from higher-than-expected demand during lead time. Answer (B) is incorrect because the economic order quantity is the order quantity that minimizes total inventory costs. Answer (C) is correct. JIT is a manufacturing philosophy popularized by the Japanese that combines purchasing, production, and inventory control. As with MRP, minimization of inventory is a goal; however, JIT also encompasses changes in the production process itself. An emphasis on quality and a pull of materials related to demand are key differences between JIT and MRP. The factory is organized so as to bring materials and tools close to the point of use rather than keeping them in storage areas. A key element of the JIT system is reduction or elimination of waste of materials, labor, factory space, and machine usage. Minimizing inventory is the key to reducing waste. When a part is needed on the production line, it arrives just in time, not before. Daily deliveries from suppliers are the ultimate objective, and some Japanese users have been able to get twice-daily deliveries. Answer (D) is incorrect because the master budget is the detailed financial plan for the next period.

[235] Gleim #: 2.73 -- Source: CIA 595 III-98 One of the elements included in the economic order quantity (EOQ) formula is

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A. B. C. D.

Safety stock. Yearly demand. Selling price of item. Lead time for delivery. Answer (A) is incorrect because the safety stock is not included in the basic EOQ formula. Answer (B) is correct. The basic EOQ formula is used to minimize the total of inventory carrying and ordering costs. The basic EOQ equals the square root of a fraction consisting of a numerator equal to the product of twice the unit periodic demand and the variable cost per order and a denominator equal to the unit periodic carrying cost. Answer (C) is incorrect because the selling price of the item is not included in the basic EOQ formula. Answer (D) is incorrect because the lead time for delivery is not included in the basic EOQ formula.

[Fact Pattern #16] Using an EOQ analysis (assuming a constant demand), it is determined that the optimal order quantity is 2,500. The company desires a safety stock of 500 units. A five-day lead time is needed for delivery. Annual inventory holding costs equal 25% of the average inventory level. It costs the company $4 per unit to buy the product, which it sells for $8. It costs the company $150 to place a detailed order, and the monthly demand for the product is 4,000 units. [236] Gleim #: 2.74 -- Source: CIA 595 III-99 (Refers to Fact Pattern #16) Annual inventory holding costs equal

A. B. C. D.

$750 $1,250 $1,750 $2,250 Answer (A) is incorrect because $750 results from subtracting instead of adding the cost of holding safety stock. Answer (B) is incorrect because $1,250 ignores safety stock. Answer (C) is correct. Given that demand is constant and the EOQ is 2,500 units, the average inventory level without regard to safety stock is 1,250 units (2,500 2). Adding safety stock results in an average level of 1,750 units (1,250 + 500). Given also that annual holding costs are 25% of average inventory and that unit cost is $4, total annual holding cost is $1,750 [(1,750 units $4) 25%]. Answer (D) is incorrect because $2,250 results from double counting the cost of holding safety stock.

[237] Gleim #: 2.75 -- Source: CIA 595 III-100 (Refers to Fact Pattern #16) Total inventory ordering costs per year equal

A. B. C. D.

$1,250 $2,400 $2,880 $3,600

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Answer (A) is incorrect because $1,250 equals the annual holding cost of the average inventory excluding safety stock. Answer (B) is incorrect because $2,400 assumes an EOQ of 3,000 units. Answer (C) is correct. Total annual demand is 48,000 units (4,000 per month 12). Hence, total annual ordering costs equal $2,880 [$150 cost per order (48,000 units 2,500 EOQ)]. Answer (D) is incorrect because $3,600 assumes an EOQ of 2,000 units. [238] Gleim #: 2.76 -- Source: CIA 1195 III-66 An organization sells a product for which demand is uncertain. Management would like to ensure that there is sufficient inventory on hand during periods of high demand so that it does not lose sales (and customers). To do so, the organization should

A. B. C. D.

Keep a safety stock. Use a just-in-time inventory system. Employ a materials requirements planning system. Keep a master production schedule. Answer (A) is correct. Safety stock is inventory maintained to reduce the number of stockouts resulting from higherthan-expected demand during lead time. Maintaining a safety stock avoids the costs of stockouts, e.g., lost sales and customer dissatisfaction. Answer (B) is incorrect because a just-in-time inventory system involves the purchase of materials and production of components immediately preceding their use. Answer (C) is incorrect because materials requirements planning is a system for scheduling production and controlling the level of inventory for components with dependent demand. Answer (D) is incorrect because a master production schedule is a statement of the timing and amounts of individual items to be produced.

[239] Gleim #: 2.77 -- Source: CIA 1195 III-97 The economic order quantity is the size of the order that minimizes total inventory costs which include ordering and holding costs. It can be calculated using the formula

If: Q = order size in units, D = annual demand in units, p = cost per purchase order, s = carrying cost per year for one unit of inventory. If the annual demand decreases by 36% the optimal order size will

A. B. C. D.

Decrease by 20%. Increase by 20%. Increase by 6%. Decrease by 6%.

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Answer (A) is correct. If D decreases by 36%, that is, from 100% to 64%, the EOQ will decrease by 20%.

Answer (B) is incorrect because the new EOQ decreases to 80% of its former value. Answer (C) is incorrect because 6% is the square root of 36%. Answer (D) is incorrect because 6% is the square root of 36%. [240] Gleim #: 2.78 -- Source: CIA 1196 III-95 The economic order quantity, Q, is the size of the order that minimizes total inventory costs. These costs, which are composed of ordering and holding costs, can be computed using the following expression:

If: TC Q D F p s

= = = = = =

total inventory costs size of each order annual demand in units fixed costs of ordering variable cost of placing one order holding cost per year for one unit of inventory

The following inventory information is available for an organization (costs stated in currency units): Annual demand (D) Variable cost of placing one order (p) Holding cost per unit (s) Economic order quantity (Q) Fixed cost of ordering 20,000 units CU100 CU1 2,000 units CU0

If the organization decides to order 4,000 units at a time rather than 2,000 units, by how much will its total inventory costs change?

A. B. C. D.

CU500 increase. CU1,000 increase. CU1,000 decrease. CU900 increase.

Answer (A) is correct. When the order size is 2,000 units, the variable inventory costs are CU2,000 {[(2,000 units CU1) 2] + [(20,000 units 2,000 units) CU100]}. When the order size is 4,000 units, the variable inventory costs are CU2,500 {[(4,000 units CU1) 2] + [(20,000 units 4,000 units) CU100]}. The increase in inventory costs is CU500 (CU2,500 CU2,000). Answer (B) is incorrect because a CU1,000 increase omits the change in the number of orders. Answer (C) is incorrect because increasing the order size increases total costs. The EOQ is 2,000 units. Answer (D) is incorrect because a CU900 increase results from an order size of 5,000 units.

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[241] Gleim #: 2.79 -- Source: Publisher Which of the following is the method of adding a standard markup to the cost of the product?

A. B. C. D.

Penetration pricing. Going-rate pricing. Cost-based pricing. Price skimming. Answer (A) is incorrect because penetration pricing is a new product pricing method in which an introductory price is set relatively low to attract as many customers as possible. Answer (B) is incorrect because going-rate pricing is a method of pricing based largely on competitors prices. Answer (C) is correct. Cost-based pricing is a pricing method in which a standard markup or target profit is added to the cost of the product in determining the products sales price. Answer (D) is incorrect because price skimming sets the introductory price relatively high to attract buyers who are not concerned with price.

[242] Gleim #: 2.80 -- Source: Publisher Which of the following is not a component of physical distribution?

A. B. C. D.

Transportation. Pricing. Location of retail outlets. Warehousing. Answer (A) is incorrect because a physical distribution system includes transportation. Answer (B) is correct. Physical distribution (market logistics) involves planning, implementing, and controlling the movement of materials and final goods to meet customer needs while earning a profit. Physical distribution systems coordinate suppliers, purchasing agents, marketers, channels, and customers. They include warehousing, transportation, and retail outlets. Answer (C) is incorrect because a physical distribution system includes the location of retail outlets. Answer (D) is incorrect because a physical distribution system includes warehousing.

[243] Gleim #: 2.81 -- Source: Publisher Physical distribution is the moving of finished products to

A. B. C. D.

Retail outlets. Shipping point. Consumers. Warehouses. Answer (A) is incorrect because physical distribution is the efficient movement of finished products to consumers. Answer (B) is incorrect because physical distribution is the efficient movement of finished products to consumers. Answer (C) is correct. Physical distribution is the efficient management of supply chains. It controls value-added flows from suppliers to consumers. Answer (D) is incorrect because physical distribution is the efficient movement of finished products to consumers.

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[244] Gleim #: 2.82 -- Source: Publisher Intensive distribution is most likely to be used for

A. B. C. D.

Shopping goods. Specialty goods. Convenience goods. Unsought goods. Answer (A) is incorrect because shopping goods are usually sold through selective distribution. Answer (B) is incorrect because specialty goods are usually sold through selective or exclusive distribution. Answer (C) is correct. Convenience goods are consumer goods and services that are usually low-priced and widely available. Consumers buy them often and with a minimum of comparison and effort. Examples are soap and newspapers. Producers of convenience goods ordinarily use intensive distribution to sell their products through a large number of retail or wholesale units. Answer (D) is incorrect because unsought goods, e.g., life insurance, are often marketed through personal selling.

[245] Gleim #: 2.83 -- Source: CMA 691 4-4 A decrease in inventory order costs will

A. B. C. D.

Decrease the economic order quantity. Increase the reorder point. Increase the economic order quantity. Decrease the holding cost percentage. Answer (A) is correct. A decrease in inventory ordering costs should decrease the economic order quantity. The effect is that more orders can be made (of smaller quantities) without increasing costs. Accordingly, in the EOQ model, ordering cost is a numerator value. Answer (B) is incorrect because the reorder point is based on lead time, not the EOQ model. Answer (C) is incorrect because the EOQ does not increase when inventory order costs decrease. Answer (D) is incorrect because the holding cost percentage will always be identical to the ordering cost percentage in accordance with the fundamental calculus underlying the EOQ model.

[246] Gleim #: 2.84 -- Source: CMA 1294 4-7 Which one of the following items is not directly reflected in the basic economic order quantity (EOQ) model?

A. B. C. D.

Interest on invested capital. Inventory obsolescence. Public warehouse rental charges. Quantity discounts lost on inventory purchases. Answer (A) is incorrect because interest on invested capital is considered in the basic EOQ model. Answer (B) is incorrect because inventory obsolescence is considered in the basic EOQ model. Answer (C) is incorrect because public warehouse rental charges is considered in the basic EOQ model. Answer (D) is correct. The basic EOQ model minimizes the sum of ordering (or setup) and carrying costs. Included in the formula are annual demand, ordering (or setup) costs, and carrying costs. Carrying costs include warehousing costs, insurance, spoilage, obsolescence, and interest on invested capital. The cost of the inventory itself and any quantity discounts lost on inventory purchases are not components of the EOQ model.

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[247] Gleim #: 2.85 -- Source: CMA 1286 5-10 In production management, product breakdown into component parts and lead times for procuring these parts is necessary for

A. B. C. D.

A critical path method (CPM) system. A materials requirements planning (MRP) system. An economic order quantity (EOQ) system. An ABC system. Answer (A) is incorrect because a CPM system is a project management and scheduling technique that determines the longest time path from the first to the last event for a project. Answer (B) is correct. Materials requirements planning (MRP) is usually considered a computer-based information system designed to plan and control raw materials used in a production setting. It assumes that estimated demand for materials is reasonably accurate and that suppliers can deliver based upon this accurate schedule. It is crucial that delivery delays be avoided because, under MRP, production delays are almost unavoidable if the materials are not on hand. An MRP system uses a parts list, often called a bill of materials, and lead times for each type of material to obtain materials just as they are needed for planned production. Answer (C) is incorrect because the EOQ model does not adjust for the dependent demand for the components of an inventory item. Answer (D) is incorrect because the main purpose of the ABC system is to increase control over items accounting for the most profit.

[248] Gleim #: 2.86 -- Source: CMA 1286 5-11 The inventory model that follows the concept that 80% of the value of an inventory is in 20% of the inventory items is the

A. B. C. D.

ABC system. Economic order quantity (EOQ) model. Just-in-time inventory system. Materials requirements planning (MRP) system. Answer (A) is correct. The ABC method of inventory control requires management to exert greatest control over the A classification items, which usually include a relatively small percentage of total items but a high percentage of the dollar volume. This method is analogous to the 80/20 rule, which says, for instance, that 20% of the customers account for 80% of the profit. Answer (B) is incorrect because the EOQ model is intended to minimize the sum of holding and ordering costs. Answer (C) is incorrect because a just-in-time system attempts to reduce holding costs by scheduling deliveries of materials as closely as possible to when they are needed in production. Answer (D) is incorrect because an MRP system recognizes that the demand for one inventory item creates a dependent demand for the components of that item.

[249] Gleim #: 2.87 -- Source: CMA 688 5-22 When a specified level of safety stock is carried for an item in inventory, the average inventory level for that item

A. B. C. D.

Decreases by the amount of the safety stock. Is one-half the level of the safety stock. Increases by one-half the amount of the safety stock. Increases by the amount of the safety stock.

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Answer (A) is incorrect because the average inventory level increases by the amount of the safety stock. Answer (B) is incorrect because the average inventory level increases by the amount of the safety stock. Answer (C) is incorrect because the average inventory level increases by the amount of the safety stock. Answer (D) is correct. If there is no safety stock, the average level of inventory will be one-half of the economic order quantity. For example, if the EOQ is 500, the basic model predicts that the average inventory level will be 250. The company will have 500 units immediately after a purchase and zero immediately before the receipt of the next purchase (replenishment is assumed to be instantaneous). However, safety stock increases the average inventory level by the amount of the safety stock. The modified EOQ model assumes that safety stock will never be used. Thus, if a safety stock of 100 is carried by the company in the example, the average inventory level will increase to 350. Inventory will be 600 units immediately upon receipt of a purchase and 100 units immediately before the receipt of the next purchase. [250] Gleim #: 2.88 -- Source: CIA 597 IV-78 A distribution channel moves goods from producers to customers. Suppose a channel has four producers, each serving the same four customers, and no middlemen. If a distributor is introduced, the number of contacts (among producers, customers, and the distributor) in the channel will

A. B. C. D.

Be unaffected. Decrease from 8 to 4. Increase from 8 to 16. Decrease from 16 to 8. Answer (A) is incorrect because the introduction of a distributor will affect the number of contacts in the marketing channel. Answer (B) is incorrect because the number of contacts declined from 16 to 8. Answer (C) is incorrect because the number of contacts decreased. Answer (D) is correct. The number of contacts without a distributor is 16 (four producers four customers). The number with a distributor is 8 (four producers + four customers). Thus, the effort required of producers and consumers is reduced by the distributor, thereby increasing marketing efficiency.

[251] Gleim #: 2.89 -- Source: CIA R98 III-32 An appropriate technique for planning and controlling manufacturing inventories, such as raw materials, components, and subassemblies whose demand depends on the level of production is

A. B. C. D.

Materials requirements planning. Regression analysis. Capital budgeting. Linear programming. Answer (A) is correct. Materials requirements planning (MRP) is a system that translates a production schedule into requirements for each component needed to meet the schedule. It is usually implemented in the form of a computerbased information system designed to plan and control raw materials used in production. It assumes that forecasted demand is reasonably accurate and that suppliers can deliver based upon this accurate schedule. MRP is a centralized push-through system; output based on forecasted demand is pushed through to the next department or to inventory. Answer (B) is incorrect because regression analysis is used to fit a linear trend line to a dependent variable based on one or more independent variables. Answer (C) is incorrect because capital budgeting is the process of planning expenditures for long-lived assets. It involves choosing among investment proposals using a ranking procedure. Answer (D) is incorrect because linear programming is a decision model concerned with allocating scarce resources to maximize profit or minimize costs.

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[252] Gleim #: 2.90 -- Source: CIA 1194 IV-79 Price skimming involves

A. B. C. D.

Setting a low introductory price. Setting a high introductory price. Setting different freight charges for customers in different zones. Using markups tied closely to the price paid for a product. Answer (A) is incorrect because it refers to penetration pricing. Answer (B) is correct. Price skimming is used when a new product is introduced at the highest price possible given the benefits of the product. For market skimming to work, the product must appear to be worth its price, the costs of producing a small volume cannot be so high that they eliminate the advantage of charging more, and competitors cannot enter the market and undercut the price. Answer (C) is incorrect because it refers to zone pricing. Answer (D) is incorrect because it relates to pricing by intermediaries.

[253] Gleim #: 2.91 -- Source: CIA 1195 IV-75 Which of the following price adjustment strategies is designed to smooth production for the selling firm?

A. B. C. D.

Cash discounts. Quantity discounts. Functional discounts. Seasonal discounts. Answer (A) is incorrect because cash discounts encourage prompt payment. Answer (B) is incorrect because quantity discounts encourage large volume purchases. Answer (C) is incorrect because functional or trade discounts are provided to channel members in return for the performance of certain functions, such as selling, storing, and record keeping. Answer (D) is correct. Seasonal discounts are designed to smooth production by the selling firm. For example, a ski manufacturer offers seasonal discounts to retailers in the spring and summer to encourage early ordering.

[254] Gleim #: 2.92 -- Source: Publisher A seller that does which of the following is engaged in uniform delivered pricing?

A. B. C. D.

Charges each customer its actual freight costs. Charges the same price, inclusive of shipping, to all customers regardless of location. Absorbs all of the actual freight charges. Sets differential freight charges for customers on the basis of their location. Answer (A) is incorrect because it refers to FOB-origin pricing. Answer (B) is correct. A seller that uses uniform delivered pricing charges the same price, inclusive of shipping, to all customers regardless of their location. Answer (C) is incorrect because it refers to freight-absorption pricing. Answer (D) is incorrect because it refers to zone pricing.

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[255] Gleim #: 2.93 -- Source: Publisher Jabberwock Corporations corporate headquarters is in Carroll City. Jabberwock also has six distribution centers, one in Carroll City and the others located throughout North America. Jabberwock sets freight costs based on the distance of the destination city from Carroll City. What is this pricing method?

A. B. C. D.

Basing-point pricing. Zone pricing. FOB-origin pricing. Cost-plus pricing. Answer (A) is correct. Basing-point pricing charges each customer the freight costs incurred from a specified city to the destination, regardless of the actual point of origin of the shipment. Answer (B) is incorrect because zone pricing sets differential freight charges for customers on the basis of their location. Answer (C) is incorrect because FOB-origin pricing charges each customer its actual freight costs. Answer (D) is incorrect because cost-plus pricing is not a geographical pricing method.

[256] Gleim #: 2.94 -- Source: Publisher Manx Co. produces and sells two products. Product A costs $10 per unit and Product B costs $5 per unit. The As are selling very well, but sales of B are low. In order to increase sales of B, Manx has begun setting a price of $13 for one of each. This pricing method is

A. B. C. D.

Product-bundle pricing. By-product pricing. Value pricing. Collusive pricing. Answer (A) is correct. Product-bundle pricing entails selling combinations of products at a price lower than the combined prices of the individual items. This strategy promotes sales of items consumers might not otherwise buy. Answer (B) is incorrect because it refers to the practice of accepting prices at any amount in excess of storing and delivering the by-products. Answer (C) is incorrect because it refers to the practice of redesigning products to improve quality without raising prices, or offering the same quality at lower prices. Answer (D) is incorrect because collusive pricing occurs when companies conspire to restrict output and set artificially high prices.

[257] Gleim #: 2.95 -- Source: Publisher Selling below cost in other countries is called

A. B. C. D.

Predatory pricing. Price discrimination. Dumping. Collusive pricing.

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Answer (A) is incorrect because it is pricing products below cost. It may be done both domestically and in other countries. Answer (B) is incorrect because price discrimination is charging different prices to different customers. Answer (C) is correct. Dumping, which refers to selling below cost in other countries, is an inappropriate pricing tactic that may trigger retaliatory tariffs and other sanctions. Answer (D) is incorrect because collusive pricing occurs when companies conspire to restrict output and set artificially high prices. [258] Gleim #: 2.96 -- Source: Publisher All of the following are objectives of pricing except

A. B. C. D.

Image oriented objectives. Profit maximization. Stabilization. Production maximization. Answer (A) is incorrect because it is a pricing objective. Answer (B) is incorrect because it is a pricing objective. Answer (C) is incorrect because it is a pricing objective. Answer (D) is correct. Pricing objectives include profit maximization, which assumes that all firms select the price that results in the highest profit target margin maximization, which is stated as a percentage ratio of profits to sales volume-oriented objectives, which refers to setting prices to meet target sales volumes or market shares image oriented objectives, which refers to setting prices to enhance the consumers perception of the firms merchandise mix 5. stabilization objectives, which refers to setting prices to maintain a stable relationship between the firms prices and the industry leaders prices Price setting is not a factor in maximizing production. 1. 2. 3. 4.

[259] Gleim #: 2.97 -- Source: Publisher Monolith Company, which produces Hal computers, uses a target pricing and costing approach. The following is Monoliths costs and revenues for the year just ended: Number of computers sold Sales price per computer Cost of goods sold Operating costs excluding production 10,000 $1,500 $8,000,000 $5,500,000

Monolith plans to increase sales of computers to 15,000 in the next year by reducing the unit price to $1,250. If Monolith wishes to achieve a unit target operating income of 10%, by what amount must it reduce the full cost per unit?

A. B. C. D.

$100 $125 $225 $250

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Answer (A) is incorrect because it equals the current full cost per unit minus the new unit target price. Answer (B) is incorrect because it is the unit target operating income. Answer (C) is correct. Unit target operating income is $125 (10% $1,250 target price). Thus, the unit target full cost is $1,125 ($1,250 $125). The current full cost per unit is $1,350 [($8,000,000 cost of goods sold + $5,500,000 operating costs excluding production) 10,000 units sold], so the necessary reduction in full cost per unit is $225 ($1,350 $1,125). Answer (D) is incorrect because it is the change in unit price. [260] Gleim #: 2.98 -- Source: CIA 1194 IV-78 Market-based pricing involves

A. B. C. D.

Adding a standard markup to the cost of the product. Determining the price at which the product will earn a target profit. Basing prices on the products perceived value. Basing prices on competitors prices. Answer (A) is incorrect because adding a standard markup to the cost of the product is cost-plus pricing. Answer (B) is incorrect because determining the price at which the product will earn a target profit is target-profit pricing. Answer (C) is correct. Market-based pricing involves basing prices on the products perceived value rather than on the sellers cost. Nonprice variables in the marketing mix augment the perceived value. For example, a cup of coffee may have a higher price at an expensive restaurant than at a fast food outlet. Answer (D) is incorrect because basing prices on competitors prices is going-rate pricing.

[261] Gleim #: 2.99 -- Source: CMA 1296 4-6 Several surveys point out that most managers use full product costs, including unit fixed costs and unit variable costs, in developing cost-based pricing. Which one of the following is least associated with cost-based pricing?

A. B. C. D.

Price stability. Price justification. Target pricing. Fixed-cost recovery. Answer (A) is incorrect because full-cost pricing promotes price stability. It limits the ability to cut prices. Answer (B) is incorrect because full-cost pricing provides evidence that the company is not violating antitrust laws against predatory pricing. Answer (C) is correct. A target price is the expected market price of a product, given the companys knowledge of its customers and competitors. Hence, under target pricing, the sales price is known before the product is developed. Subtracting the unit target profit margin determines the long-term unit target cost. If cost-cutting measures do not permit the product to be made at or below the target cost, the product will be abandoned. Answer (D) is incorrect because full-cost pricing has the advantage of recovering the full long-term costs of the product. In the long term, all costs are relevant.

[262] Gleim #: 2.100 -- Source: Publisher Value engineering is

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A. B. C. D.

A policy of seeking continuous improvement in all phases of company activities. A method of determining prices based on a cost determination. An element of a marketing mix strategy. A systematic approach to assessing all aspects of cost buildup for a product. Answer (A) is incorrect because it refers to Kaizen. Answer (B) is incorrect because it refers to cost-plus pricing. Answer (C) is incorrect because value added engineering is not directly related to marketing mix strategies. Answer (D) is correct. Value engineering is a means of reaching targeted cost levels. It is a systematic approach to assessing all aspects of the value chain cost buildup for a product: R&D, design of products, design of processes, production, marketing, distribution, and customer service. The purpose is to minimize costs without sacrificing customer satisfaction.

[263] Gleim #: 2.101 -- Source: Publisher Sunshine Co. is a producer of citrus flavored dessert products. Its most popular product is its key lime pies, which are made with many fine ingredients, including egg yolks. Sunshine also sells the egg whites that are left over from its production process. These egg whites are sold at any price that is greater than the cost of storing and delivering them. The pricing of the egg whites is

A. B. C. D.

By-product pricing. Captive-product pricing. Product-bundle pricing. Value pricing. Answer (A) is correct. By-product pricing usually sets prices at any amount in excess of storing and delivering byproducts. Such prices allow the seller to reduce the costs and therefore the prices of the main products. Answer (B) is incorrect because captive-product pricing involves products that must be used with a main product. Answer (C) is incorrect because product-bundle pricing entails selling combinations of products at a price lower than the combined prices of individual items. Answer (D) is incorrect because value pricing entails redesigning products to improve quality without raising prices or offering the same quality at lower prices.

[264] Gleim #: 2.102 -- Source: Publisher Which of the following is a definition of predatory pricing?

A. B. C. D.

Pricing products below cost to destroy competitors. Pricing products at different prices for different customers. Conspiring to restrict output and set artificially high prices. Selling below cost in other countries. Answer (A) is correct. Predatory pricing is the practice of pricing products below cost to destroy competitors. The U.S. Supreme Court has held that a price is predatory if it is below an appropriate measure of costs and the seller has a reasonable prospect of recovering its losses in the future through higher prices or greater market share. Answer (B) is incorrect because it refers to price discrimination. Answer (C) is incorrect because it refers to collusive pricing. Answer (D) is incorrect because it refers to dumping.

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[265] Gleim #: 2.103 -- Source: Publisher Prices vary directly with capacity usage under

A. B. C. D.

Collusive pricing. Peak-load pricing. Market-based pricing. Cost-based pricing. Answer (A) is incorrect because it refers to the illegal practice of conspiring to restrict output and set artificially high prices. Answer (B) is correct. Under peak-load pricing, prices vary directly with capacity usage. Thus, when idle capacity is available, that is, when demand falls, the price of a product or service tends to be higher given a peak-load pricing approach. Answer (C) is incorrect because it involves basing prices on the products perceived value. Answer (D) is incorrect because it involves making a cost determination and setting a price that will recover costs and provide a return on investment.

[266] Gleim #: 2.104 -- Source: Publisher Which of the following is a false statement about cost-based pricing?

A. B. C. D.

A cost-based price should cover costs and provide the desired return on investment. A commonly used cost-plus pricing formula is to add a markup percentage to the total cost. Variable costs may not be used as the basis for costs. A cost-plus price equals the cost plus a markup. Answer (A) is incorrect because it is a true statement about cost-based pricing. Answer (B) is incorrect because it is a true statement about cost-based pricing. Answer (C) is correct. Cost-based pricing begins with a cost determination followed by setting a price that will recover the value chain costs and provide the desired return on investment. A cost-plus price equals the cost plus a markup. Cost may be defined in many ways. Most companies use either absorption manufacturing cost or total cost when calculating the price. Variable costs may be used as the basis for cost, but then fixed costs must be covered by the markup. Answer (D) is incorrect because it is a true statement about cost-based pricing.

[267] Gleim #: 2.105 -- Source: Publisher A company uses a target pricing and costing approach. The following is its costs and revenues for the current year:

Units sold Sales price per unit Cost of goods sold Operating costs excluding production

100,000 $10 $515,000 $335,000

The company intends to increase unit sales to 120,000 in the next year by reducing the unit price to $8. If the company is to achieve a unit target operating income of 15%, by what amount must it reduce the full cost per unit?

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A. B. C. D.

$0.50 $1.20 $1.50 $1.70 Answer (A) is incorrect because it equals the current full cost per unit minus the new unit target price. Answer (B) is incorrect because it is the unit target operating income. Answer (C) is incorrect because it is the change in unit price. Answer (D) is correct. Unit target operating income is $1.20 (15% $8 target price). Thus, the unit target full cost is $6.80 ($8 $1.20). The current full cost per unit is $8.50 [$515,000 cost of goods sold + $335,000 operating costs excluding production) 100,00 units sold], so the necessary reduction in full cost per unit is $1.70 ($8.50 $6.80).

[268] Gleim #: 2.106 -- Source: Publisher A situation in which companies conspire to restrict output and set artificially high prices is known as:

A. B. C. D.

Collusive pricing. Predatory pricing. Price discrimination. Market-based pricing. Answer (A) is correct. Collusive pricing is illegal. It involves two or more competitors conspiring to restrict output and charge artificially high prices. Answer (B) is incorrect because predatory pricing occurs when a company sells products below cost to destroy competitors. Answer (C) is incorrect because price discrimination occurs when different prices are charged to different customers. Answer (D) is incorrect because market-based pricing bases prices on a products perceived value rather than on cost.

[269] Gleim #: 2.107 -- Source: CIA 595 IV-74 Which of the following pricing policies involves the selling company setting freight charges to customers at the actual average freight cost?

A. B. C. D.

Freight absorption pricing. Uniform delivered pricing. Zone pricing. FOB-origin pricing. Answer (A) is incorrect because, in freight absorption pricing, the selling company absorbs all or part of the actual freight charges. Customers are not charged actual delivery costs. Answer (B) is correct. In uniform delivered pricing, the company charges the same price, inclusive of shipping costs, to all customers regardless of their location. This price is the companys average actual freight cost. Thus, both nearby and distant customers are charged the same amount. This policy is easy to administer, permits the company to advertise one price nationwide, and facilitates marketing to faraway customers. Answer (C) is incorrect because, in zone pricing, differential freight charges are set for customers on the basis of their location. Customers are not charged actual average freight costs. Answer (D) is incorrect because, in FOB-origin pricing, each customer pays its actual freight costs.

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[270] Gleim #: 2.108 -- Source: Publisher Setting the introductory price of a new product relatively high is

A. B. C. D.

Market-based pricing. Price skimming. Penetration pricing. Pricing by intermediaries. Answer (A) is incorrect because the price is based on buyer perceptions in market-based pricing, rather than simply being set at a high price. Answer (B) is correct. Price skimming is the practice of setting an introductory price relatively high to attract buyers who are not concerned about price and to recover research and development costs rather quickly. The opposite approach is to use penetration pricing, which involves setting a relatively low price to gain deep market penetration quickly. Answer (C) is incorrect because penetration pricing sets a relatively low price to gain deep market penetration quickly. Answer (D) is incorrect because pricing by intermediaries does not describe the setting of a high introductory price.

[271] Gleim #: 2.109 -- Source: Publisher Washboard Inc. charges customers the shipping costs incurred from Detroit to the destination regardless of the shipping point of origin. What is this pricing method commonly called?

A. B. C. D.

Discriminatory pricing. Zone pricing. Basing-point pricing. FOB-origin pricing. Answer (A) is incorrect because it is not discriminatory to charge everyone the same from the same point. Answer (B) is incorrect because zone pricing differs by region of the country to which a shipment is made. Answer (C) is correct. Basing-point pricing charges each customer the freight costs incurred from a specified city to the destination regardless of the actual point of origin of the shipment. Answer (D) is incorrect because FOB-origin pricing charges each customer its actual freight costs.

[272] Gleim #: 2.110 -- Source: Publisher A pricing strategy that sells combinations of products at a price lower than the combined prices of the individual items is

A. B. C. D.

Predatory pricing. Going-rate pricing. Product-bundle pricing. Captive-product pricing. Answer (A) is incorrect because predatory prices are prices set below cost to destroy competitors. Answer (B) is incorrect because this means charging the going rate in the market. Answer (C) is correct. Product-bundle pricing is a strategy to promote items consumers might not otherwise buy by selling combinations of products at a price lower than the prices of the individual items combined. Answer (D) is incorrect because captive-product pricing involves charging a low price for a main product (such as a razor), while razor blades are sold at a high markup. Once a person has a razor, he has to buy blades.

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[273] Gleim #: 2.111 -- Source: Publisher Which of the following statements is true with respect to value engineering? I. Value engineering is a means of reaching targeted cost levels. II. Value engineering is the Japanese concept that emphasizes continuous improvement in all phases of company activities through numerous minor changes. III. Value engineering requires distinguishing between cost incurrence and locked-in costs, with an emphasis on controlling costs at the design stage.

A. B. C. D.

Items I and II only. Items I and III only. Items II and III only. Items I, II, and III. Answer (A) is incorrect because the Japanese concept of continuous improvement is known as Kaizen. Answer (B) is correct. Value engineering is a means of reaching targeted cost levels. Value engineering requires distinguishing between cost incurrence and locked-in costs, with emphasis on controlling costs at the design stage. It is not Japanese. Answer (C) is incorrect because the Japanese concept of continuous improvement is known as Kaizen. Answer (D) is incorrect because the Japanese concept of continuous improvement is known as Kaizen.

[274] Gleim #: 2.112 -- Source: CIA 1195 IV-76 In which product-mix pricing strategy is it appropriate for the seller to accept any price that exceeds the storage and delivery costs for the product?

A. B. C. D.

By-product pricing. Optional-product pricing. Captive-product pricing. Product-bundle pricing. Answer (A) is correct. A by-product is a product of relatively minor importance generated during the production of one or more other products. Its production entails no additional costs. Any amount received above the storage and delivery costs for a by-product allows the seller to reduce the main products price to make it more competitive. Answer (B) is incorrect because optional products are offered for sale along with the main product. They are unlikely to have a zero production cost, so the seller must receive a price above their storage and delivery costs. Answer (C) is incorrect because captive products must be used along with the main product, such as film for use with a camera. Sellers often make their profits on the captive products rather than on the main product, which is sold at a low price. The captive products therefore will be priced well above the storage and delivery costs. Answer (D) is incorrect because product bundles are combinations of products sold together at a reduced price, such as season tickets for a theater. Products are bundled to promote the sale of certain items that consumers might not otherwise purchase. The combined price of the bundle must be low enough to encourage consumers to buy the bundle but must recover production costs and provide some profit for the seller, so the price must exceed storage and delivery costs.

[275] Gleim #: 2.113 -- Source: Publisher If a U.S. manufacturers price in the U.S. market is below an appropriate measure of costs and the seller has a reasonable prospect of recovering the resulting loss in the future through higher prices or a greater market share, the seller has engaged in

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A. B. C. D.

Collusive pricing. Dumping. Predatory pricing. Price discrimination. Answer (A) is incorrect because collusive pricing involves a conspiracy to set higher prices. Answer (B) is incorrect because dumping is defined under U.S. law as sale by a non-U.S. company in the U.S. market of a product below its market value in the country where it was produced. Such sale is illegal if it threatens material injury to a U.S. industry. Answer (C) is correct. Predatory pricing is intentionally pricing below cost to eliminate competition and reduce supply. Federal statutes and many state laws prohibit the practice. The U.S. Supreme Court has held that pricing is predatory when two conditions are met: (1) the sellers price is below an appropriate measure of its costs, and (2) it has a reasonable prospect of recovering the resulting loss through higher prices or greater market share. Answer (D) is incorrect because price discrimination entails charging different prices to different customers for essentially the same product if the effect is to lessen competition substantially; to tend to create a monopoly; or to injure, destroy, or prevent competition.

[276] Gleim #: 2.114 -- Source: Publisher Flesher Furniture Company applies a target pricing and costing approach. The following information about costs and revenues of Fleshers product are available for the year just ended: Unit sales Unit selling price Cost of goods sold Value-chain operating costs excluding production 60,000 $400 $13,200,000 $7,920,000

Flesher plans to increase unit sales to 80,000 by reducing the products unit price to $320. If Flesher desires a unit target operating income of 12%, by what amount must it reduce the full cost per unit?

A. B. C. D.

$32.00 $38.40 $70.40 $80.00 Answer (A) is incorrect because $32.00 equals the current full cost per unit minus the new unit target price. Answer (B) is incorrect because because $38.40 is the unit target operating income. Answer (C) is correct. Unit target operating income is $38.40 (12% $320 unit target price). Hence, the unit target full cost is $281.60 ($320 $38.40). The current full cost per unit is $352.00 [($13,200,000 CGS + $7,920,000 other value chain operating costs) &divide; 60,000 units sold], so the necessary reduction in the full cost per unit is $70.40 ($352.00 $281.60). Answer (D) is incorrect because $80.00 equals the change in the unit price.

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[277] Gleim #: 2.115 -- Source: Publisher Labrador Hardware Co. has implemented the following discount policies: Customers may trade in older models of tools when buying the latest models. Customers purchasing with cash receive a 10% discount. Credit customers who pay their balances in full within 30 days receive a 5% discount. Customers who purchase supplies such as nails in bulk receive discounted prices. Labrador uses all of the following discount methods except

A. B. C. D.

Cash discounts. Quantity discounts. Allowances. Trade discounts. Answer (A) is incorrect because it is a discount offered by Labrador. Answer (B) is incorrect because it is a discount offered by Labrador. Answer (C) is incorrect because it is a discount offered by Labrador. Answer (D) is correct. Cash discounts encourage prompt payment, improve cash flows, and avoid bad debts. Quantity discounts encourage large volume purchases. Trade (functional) discounts are offered to other members of the marketing channel for performing certain services, such as selling. Seasonal discounts are offered for sales out of season. They help smooth production. Allowances such as trade-ins reduce list prices.

[278] Gleim #: 2.116 -- Source: Publisher Questions about which of the following can legally be asked in recruiting interviews?

A. B. C. D.

Age. Number of children. Kind of military discharge. Criminal record (but only for security clearance purposes). Answer (A) is incorrect because age may not be asked in a recruiting interview. Answer (B) is incorrect because number of children may not be asked in a recruiting interview. Answer (C) is incorrect because the kind of military discharge cannot be asked in a recruiting interview. Answer (D) is correct. In a recruiting interview, one may not ask about the applicants marital status, number of children, height and weight, criminal record (except for the purpose of giving a security clearance), kind of military discharge, or age.

[279] Gleim #: 2.117 -- Source: Publisher The halo effect may diminish the accuracy of the evaluation of employees. Which of the following is an example?

A. B. C. D.

A manager rates some employees as very good and some as very poor. A managers judgment of one positive trait affects his/her rating of other traits. The most recent behavior overshadows overall performance. All personnel who work together are rated within the same narrow range.

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Answer (A) is incorrect because this is not an example of the halo effect. Answer (B) is correct. The halo effect diminishes the accuracy of an evaluation when a managers judgment on one positive trait affects the rating of other traits. Answer (C) is incorrect because the recency effect is when the most recent behavior overshadows overall performance. Answer (D) is incorrect because the central tendency effect is when all personnel who work together are rated within the same narrow range. [280] Gleim #: 2.118 -- Source: Publisher Which of the following is not a characteristic of an effective evaluation system?

A. B. C. D.

Relevant. Significant. Unbiased. Highly structured. Answer (A) is incorrect because the evaluation system should be relevant. Answer (B) is incorrect because the evaluation system should be significant. Answer (C) is incorrect because the evaluation system should be unbiased. Answer (D) is correct. The system should be relevant, unbiased, significant, and practical. The evaluation system should be as objective, easy to use, clearly understood, and efficient as possible, but it is not necessary that it be highly structured.

[281] Gleim #: 2.119 -- Source: IIA, adapted An advantage of using bar codes rather than other means of identification of parts used by a manufacturer is that

A. B. C. D.

The movement of all parts is controlled. The movement of parts is easily and quickly recorded. Vendors can use the same part numbers. Vendors use the same identification methods. Answer (A) is incorrect because the movement of parts can escape being recorded with any identification method. Answer (B) is correct. A reason to use bar codes rather than other means of identification is to record the movement of parts with minimal labor costs. Answer (C) is incorrect because each vendor has its own part-numbering scheme, which is unlikely to correspond to the buyers scheme. Answer (D) is incorrect because each vendor has its own identification method, although vendors in the same industry often cooperate to minimize the number of bar-code systems that they use.

[282] Gleim #: 2.120 -- Source: IIA, adapted An appropriate technique for planning and controlling manufacturing inventories, such as raw materials, components, and subassemblies, whose demand depends on the level of production is

A. B. C. D.

Materials requirements planning. Regression analysis. Capital budgeting. Linear programming.

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Answer (A) is correct. Materials requirements planning (MRP) is an integrated computer-based system designed to plan an control dependent-demand manufacturing inventories. It assumes the forecasted demand for materials is typically dependent upon some other factor, which can be programmed into the computer. Answer (B) is incorrect because regression analysis is a statistical procedure for estimating the relation between variables. Answer (C) is incorrect because capital budgeting is used for analyzing and evaluating long-term capital investments. Answer (D) is incorrect because linear programming is a mathematical technique for maximizing or minimizing a given objective subject to certain constraints. [283] Gleim #: 2.121 -- Source: IIA, adapted If a just-in-time purchasing policy is successful in reducing the total inventory costs of a manufacturing company, which of the following combinations of cost changes would be most likely to occur?

A. B. C. D.

An increase in purchasing costs and a decrease in stockout costs. An increase in purchasing costs and a decrease in quality costs. An increase in quality costs and a decrease in ordering costs. An increase in stockout costs and a decrease in carrying costs. Answer (A) is incorrect because the supplier may ask for a concession in its selling price, which would raise the manufacturers purchasing costs. However, the manufacturing company will be receiving fewer materials at any point in time, increasing the likelihood of stockout and thereby resulting in an increase in stockout costs. Answer (B) is incorrect because the supplier may ask for a concession in its selling price, which would raise the manufacturers purchasing costs. However, the cost of quality would not necessarily be affected by the just-in-time purchasing system. Answer (C) is incorrect because with fewer purchase orders being processed by the manufacturer, the ordering costs are likely to decrease. However, the cost of quality would not necessarily be affected by the just-in-time purchasing system. Answer (D) is correct. In this situation, the company will be receiving fewer materials at any point in time, increasing the likelihood of stockout and thereby resulting in an increase in a reduction in the carrying cost. At the same time, the average inventory will be less, resulting in a reduction in the carrying cost.

[284] Gleim #: 2.122 -- Source: IIA, adapted In an economic order quantity (EOQ) model, both the costs per order and the holding costs are estimates. If those estimates are varied to determine how much the changes affect the optimal EOQ, such an analysis would be called a

A. B. C. D.

Forecasting model. Sensitivity analysis. Critical path method analysis. Decision analysis. Answer (A) is incorrect because forecasting models involve projecting data over time or developing regression models when time series data are not available. Answer (B) is correct. An economic order quantity (EOQ) sensitivity analysis involves varying the holding costs per unit and/or the order costs to determine how much the changes affect the optimal EOQ. Answer (C) is incorrect because critical path method involves project scheduling. Answer (D) is incorrect because decision analysis involves selecting the best option from alternatives.

[285] Gleim #: 2.123 -- Source: IIA, adapted When film is sold for use with a camera, this is an example of which of the following product mix pricing strategies?

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A. B. C. D.

By-product pricing. Optional product pricing. Captive product pricing. Product bundle pricing. Answer (A) is incorrect because there are no additional costs incurred other than storage and delivery for the development of this product. Therefore, the manufacturer will make a profit on any price over the cost of storage and delivery. Answer (B) is incorrect because optional products are those offered for sale along with the main product. They are unlikely to have zero production cost so the seller must receive a price above the storage and delivery costs for such products. Answer (C) is correct. Captive products are those that must be used along with the main product. Sellers often make their money on the captive products, rather than on the main product that is sold at a low price. The captive products will therefore be priced well above the storage and delivery costs. Answer (D) is incorrect because product bundles are combinations of products sold together at a reduced price, such as season tickets for a theater. Products are bundled in order to promote the sale of certain items that consumers might not otherwise purchase. The combined price of the bundle must be low enough to encourage consumers to buy the bundle, but must recover production costs and provide some profit for the seller. The price must exceed storage and delivery costs.

[286] Gleim #: 2.124 -- Source: IIA, adapted A competitive marketing strategy in which a firm specializes in serving customers overlooked or ignored by major competitors is called a

A. B. C. D.

Market leader strategy. Market challenger strategy. Market follower strategy. Market niche strategy. Answer (A) is incorrect because market leader strategies are employed by the major competitors that dominate a market. Answer (B) is incorrect because market challenger strategies are followed by runner-up companies that aggressively attack competitors to get more market share. Answer (C) is incorrect because market follower strategies are used by runner-up companies that follow competitors product offers, pricing, and market programs. Answer (D) is correct. Specializing in serving customers overlooked or ignored by major competitors is a market niche strategy. This strategy specializes along market, customer, product, or marketing mix lines.

[287] Gleim #: 2.125 -- Source: IIA, adapted Which of the following hiring procedures provides the most control over the accuracy of information submitted on an employment application?

A. Applicants are required to submit unofficial copies of their transcripts along with the application as verification of their educational credentials. B. The hiring organization calls the last place of employment for each finalist to verify the employment length and position held. C. Letters of recommendation which attest to the applicants character must be mailed directly to the hiring organization rather than being submitted by the applicant. D. Applicants are required to sign that the information on the applicant is true and correct as a confirmation of the truth of the information in the application.

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Answer (A) is incorrect because the applicant is providing the transcript, leading to a loss of independence. In addition, the transcript is unofficial, making it very easy to change the information and send a photocopy of the altered transcript. Answer (B) is correct. Calling the last place of employment for candidates to verify information represents an independent verification of employment since the hiring organization is performing the verification process. Answer (C) is incorrect because there is nothing to prevent the applicants from writing the letters themselves, putting fraudulent return address information on the letters, and mailing them. Answer (D) is incorrect because if an applicant is going to lie about information, there is no reason to believe that the applicant will not sign the applicants own name to the fraudulent information. This is not an independent verification. [288] Gleim #: 2.126 -- Source: CIA 590 IV-51 With regard to inventory management, an increase in the frequency of ordering will normally

A. B. C. D.

Reduce the total ordering costs. Have no impact on total ordering costs. Reduce total carrying costs. Have no impact on total carrying costs. Answer (A) is incorrect because total ordering costs will increase. Answer (B) is incorrect because total ordering costs will increase. Answer (C) is correct. Inventory carrying costs can sometimes be transferred to suppliers. If a seller has good enough control of demand schedules to know exactly when goods are needed, orders can be placed so that goods arrive no earlier than when actually needed. This practice relies on a supplier who is willing to take the responsibility for storing the needed inventory and shipping it to arrive on time. Suppliers are more willing to provide this type of service when they have many competitors. Answer (D) is incorrect because total carrying costs are reduced.

[289] Gleim #: 2.127 -- Source: CIA 594 IV-37 An entity sells 1,500 units of a particular item each year and orders the items in equal quantities of 500 units at a price of 5 per unit. No safety stocks are held. If the entity has a cost of capital of 12%, its annual cost of carrying inventory is

A. B. C. D.

150 180 300 900 Answer (A) is correct. The annual cost of carrying inventory equals the average inventory level times the cost per unit of inventory times the cost of capital. The average inventory level is the order quantity divided by 2. Thus, the annual cost of carrying inventory is 150 [(500 2) 5 .12]. Answer (B) is incorrect because 180 is obtained by using the total annual quantity rather than the average inventory level and by not multiplying by the unit price. Answer (C) is incorrect because 300 is obtained by using the order size rather than the average inventory level. Answer (D) is incorrect because 900 is based on the total annual quantity rather than the average inventory level.

[290] Gleim #: 2.128 -- Source: CIA 596 I-4 A perpetual inventory system uses a minimum quantity on hand to initiate purchase ordering procedures for restocking. In reviewing the appropriateness of the minimum quantity level established by the stores department, the internal auditor is least likely to consider

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A. B. C. D.

Stockout costs, including lost customers. Seasonal variations in forecasting inventory demand. Optimal order sizes determined by the economic order quantities model. Available storage space and potential obsolescence. Answer (A) is incorrect because stockout costs are directly affected by the quantity on hand. Answer (B) is incorrect because seasonal variations in demand directly affect the minimum quantity available. Answer (C) is correct. The basic economic order quantity (EOQ) model is based on the following variables: demand, variable cost per purchase order, and variable unit carrying cost. Thus, minimum stocking levels do not affect the EOQ. Answer (D) is incorrect because storage space and potential obsolescence directly affect stocking levels.

[291] Gleim #: 3.1 -- Source: CIA 597 IV-1 The measurement basis most often used to report a long-term payable representing a commitment to pay money at a determinable future date is

A. B. C. D.

Historical cost. Current cost. Net realizable value. Present value of future cash flows. Answer (A) is incorrect because historical cost is used to measure property, plant, and equipment and most inventories. Answer (B) is incorrect because some inventories are measured at current (replacement) cost. Answer (C) is incorrect because short-term receivables and some inventories are reported at net realizable value. Answer (D) is correct. The measurement basis most commonly adopted by entities in preparing their financial statements is historical cost. However, it is usually combined with other measurement bases (attributes). The attribute used to measure a long-term receivable or payable is the present or discounted value of its future cash flows.

[292] Gleim #: 3.2 -- Source: CIA 593 IV-25 In December year 1, catalogs were printed for use in a special promotion in January year 2. The catalogs were delivered by the printer on December 13, year 1, with an invoice for 70,000 attached. Payment was made in January year 2. The 70,000 should be reported as a deferred cost at the December 31, year 1 balance sheet date because of the

A. B. C. D.

Matching principle. Revenue recognition principle. Reliability principle. Cost principle. Answer (A) is correct. Matching is the simultaneous or combined recognition of revenues and expenses resulting directly and jointly from the same transactions or other events. Expenses should be associated with the revenues that they help to create. Because the catalogs are still on hand at the balance sheet date, they will not contribute to an inflow of economic benefits until the next period. Hence, the cost should be deferred and matched with the revenues of the following period. Answer (B) is incorrect because the revenue recognition principle determines the period in which revenue is recognized. Answer (C) is incorrect because reliable information is free of error and bias and is representationally faithful. Answer (D) is incorrect because the cost principle states that cost is the usual basis for recording most assets and liabilities.

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[293] Gleim #: 3.3 -- Source: CIA 1192 IV-37 Because of inexact estimates of the service life and the residual value of a plant asset, a fully depreciated asset was sold in the current year at a material gain. This gain most likely should be reported

A. B. C. D.

In the other revenues and gains section of the current income statement. As part of sales revenue on the current income statement. In the extraordinary item section of the current income statement. As an adjustment to prior periods depreciation on the statement of changes in equity. Answer (A) is correct. Income includes revenue and gains. Their essential nature is the same, and they are not treated as separate financial statement elements. Revenues occur in the course of ordinary activities. Gains may or may not occur in the course of ordinary activities. For example, gains may occur from the sale of noncurrent assets. Thus, the gain on the sale of a plant asset is not an operating item and should be classified in an income statement with separate operating and nonoperating sections in the other revenues and gains section. Answer (B) is incorrect because the asset sold was not stock in trade. Answer (C) is incorrect because extraordinary items are not reported in the financial statements or notes. Answer (D) is incorrect because the transaction is not the correction of an error in the financial statements of a prior period.

[294] Gleim #: 3.4 -- Source: CIA 595 IV-29 Assume that employees confessed to a 500,000 inventory theft but are not able to make restitution. How should this material fraud be shown in the companys financial statements?

A. Classified as a loss and shown as a separate line item in the income statement. B. Initially classified as an accounts receivable because the employees are responsible for the goods. Because they cannot pay, the loss would be recognized as a write-off of accounts receivable. C. Included in cost of goods sold because the goods are not on hand, losses on inventory shrinkage are ordinary, and it would cause the least amount of attention. D. Recorded directly to retained earnings because it is not an income-producing item. Answer (A) is correct. Expenses include losses. Their essential nature is the same, and they are not treated as separate financial statement elements. Losses may or may not occur in the course of ordinary activities. For example, they may result from nonreciprocal transactions (e.g., theft), reciprocal transactions (e.g., a sale of plant assets), or from holding assets or liabilities. Losses are typically displayed separately. Answer (B) is incorrect because no restitution will be made. Thus, recording the item as a receivable, then writing it off, is not consistent with the substance of the event. Answer (C) is incorrect because, although some inventory shrinkage is expected in the normal course of processing, fraud is abnormal. Hence, the item should be recorded as a loss. Answer (D) is incorrect because losses are included in the determination of net profit or loss. [295] Gleim #: 3.5 -- Source: CIA 591 IV-44 The assets of a liquidating entity should be shown on the balance sheet at their

A. B. C. D.

Undepreciated historical cost. Fair market value. Realizable value. Current cost.

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Answer (A) is incorrect because a going concern should report assets at their undepreciated historical cost. When liquidation appears imminent, historical cost is inappropriate for balance sheet reporting. Answer (B) is incorrect because an entity facing liquidation is expected to dispose of its assets in a forced or distressed sale and is unlikely to realize the fair value amount. The net realizable value of the assets is the appropriate amount for reporting purposes. Answer (C) is correct. When liquidation is imminent, and the going concern assumption is no longer valid, the most appropriate valuation method for assets is realizable value, which is the amount of cash currently obtainable by sale in an orderly disposal. Answer (D) is incorrect because current cost is only appropriate when the going concern assumption is applicable and the effects of changing prices are to be measured and reported in the financial statements. [296] Gleim #: 3.6 -- Source: CIA 1190 IV-27 An objective of financial reporting is

A. B. C. D.

Providing information useful to investors, creditors, donors, and other users for decision making. Assessing the adequacy of internal control. Evaluating management results compared with standards. Providing information on compliance with established procedures. Answer (A) is correct. The objectives of financial reporting are concerned with the underlying goals and purposes of accounting. They are to provide information that (1) is useful to those making investment and credit decisions, assuming that those individuals have a reasonable understanding of business and economic activities; (2) is helpful to current and potential investors and creditors and other users in assessing the amount, timing, and uncertainty of future cash flows; and (3) discloses economic resources, claims to those resources, and the changes therein. Answer (B) is incorrect because assessing the adequacy of internal control is a function of internal auditing, not financial reporting. Answer (C) is incorrect because evaluating management results compared with standards is a function of internal auditing, not financial reporting. Answer (D) is incorrect because providing information on compliance with established procedures is a function of internal auditing, not financial reporting.

[297] Gleim #: 3.7 -- Source: CIA 592 IV-29 An entity with total assets of 100,000,000 and net profit of 9,000,000 purchases staplers with an estimated life of 10 years for 1,000. In connection with the purchase, the company debits miscellaneous expense. This scenario is most closely associated with which of the following concepts or principles?

A. B. C. D.

Materiality and going concern. Relevance and neutrality. Reliability and comparability. Materiality and the balance between cost and benefit.

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Answer (A) is incorrect because the going-concern principle relates to circumstances in which there is doubt as to the viability of the enterprise. Answer (B) is incorrect because relevance and reliability are two of the principal qualitative characteristics of information in financial statements. Information is relevant if it permits users to predict the outcome of future events or confirm or correct their prior expectations. Reliability provides assurance that the information is reasonably free from error and bias and represents what it purports to represent. Thus, reliable information must be neutral, that is, free from error and bias. Answer (C) is incorrect because comparability is a principal qualitative characteristic. Financial statements must be comparable for the same entity over time and also among different entities. Information is relevant if it permits users to predict the outcome of future events or confirm or correct their prior expectations. Answer (D) is correct. In principle, wasting assets should be capitalized and depreciated. However, the effect on the financial statements of expensing rather than capitalizing and depreciating the staplers is clearly not material given that they cost 1,000 and the enterprise has total assets of 100,000,000. The choice of treatment is not likely to influence the decisions of financial statement users. The balance between benefit and cost is a pervasive constraint, not a qualitative characteristic. The benefits should exceed the cost of information. Specifically, the cost of producing the information about depreciation expense over 10 years for the staplers probably is higher than the benefits of the information for decision making. Thus, the expedient procedure of expensing the 1,000 should be followed. [298] Gleim #: 3.8 -- Source: CIA 1191 IV-29 To comply with the matching principle, the cost of labor services of an employee who participates in the manufacturing of a product normally should be charged to the income statement in the period in which the

A. B. C. D.

Work is performed. Employee is paid. Product is completed. Product is sold. Answer (A) is incorrect because direct labor cost is a product (inventoriable) cost that is normally not recognized until sale. Answer (B) is incorrect because direct labor cost is a product (inventoriable) cost that is normally not recognized until sale. Answer (C) is incorrect because direct labor cost is a product (inventoriable) cost that is normally not recognized until sale. Answer (D) is correct. Recognition of expenses occurs concurrently with recognition of increases in liabilities or decreases in assets. Expenses are recognized if the costs are directly associated with the earning of particular income items. This process is often called matching. Matching is simultaneous or combined recognition of the revenues and expenses that result directly and jointly from the same transactions or other events. This direct relationship is exemplified by the sale of a product. This transaction results in revenue (sales revenue) for receipt of cash or a receivable, the recognition of an expense (cost of sales) for the sacrifice of the product to a customer, and a decrease in inventory. The direct labor cost of manufacturing the product is absorbed by the finished goods inventory and is not recognized until sale.

[299] Gleim #: 3.9 -- Source: CIA 1192 IV-38 In recording transactions, which of the following best describes the relation between expenses and losses?

A. B. C. D.

Losses are extraordinary charges to income, whereas expenses are ordinary charges to income. Losses are material items, whereas expenses are immaterial items. Losses are expenses that may or may not arise in the course of ordinary activities. Expenses can always be prevented, whereas losses can never be prevented.

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Answer (A) is incorrect because not all losses are extraordinary items. They are not reported in the financial statements or notes. Answer (B) is incorrect because losses may be immaterial, and most expenses are material. Answer (C) is correct. Expenses are defined as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Expenses include losses. Thus, losses are not treated as separate elements. Expenses include items arising in the course of ordinary activities. Losses meet the definition of expenses but may or may not occur in the course of ordinary activities. For example, losses may result from the sale of noncurrent assets or from natural disasters. Answer (D) is incorrect because some expenses cannot be prevented, or at least not in the short run. Some losses can be prevented. [300] Gleim #: 3.10 -- Source: CIA 597 IV-12 A service enterprise keeps its accounting records on a cash basis. During the recent year, the enterprise collected $600,000 from customers. The following information is also available: Beginning of Year Accounts receivable Unearned revenue $120,000 0 End of Year $180,000 15,000

What was the amount of service revenue for the year on an accrual basis?

A. B. C. D.

$525,000 $555,000 $645,000 $675,000 Answer (A) is incorrect because $525,000 deducts rather than adds the $60,000 increase in receivables. Answer (B) is incorrect because $555,000 deducts the increase in receivables and adds the increase in unearned revenue. Answer (C) is correct. The amount of service revenue for the year on an accrual basis equals $645,000 ($600,000 cash collected $15,000 unearned revenue + $60,000 increase in accounts receivable). Answer (D) is incorrect because $675,000 adds the $15,000 increase in unearned revenue.

[301] Gleim #: 3.11 -- Source: CIA 1195 IV-3 The correct order of the following steps of the accounting cycle is

A. B. C. D.

Posting, closing, adjusting, reversing. Posting, adjusting, closing, reversing. Posting, reversing, adjusting, closing. Adjusting, posting, closing, reversing.

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Answer (A) is incorrect because adjusting entries are made prior to closing. Answer (B) is correct. The order of the steps in the accounting cycle is identification and measurement of transactions and other events required to be recognized, journalization, posting from the journals to the ledgers, the development of a trial balance, adjustments to produce an adjusted trial balance, statement presentation, closing, taking a postclosing trial balance (optional), and making reversing entries (optional). Answer (C) is incorrect because reversing entries are made after adjustments and closing entries. Answer (D) is incorrect because posting is done prior to adjusting. [302] Gleim #: 3.12 -- Source: CIA 596 IV-5 An entity has made all necessary adjusting entries and is now closing its accounts for the period. Dividends of 30,000 were declared and distributed during the year. The entry to close the dividends account would be

A. Retained earnings Dividends B. Dividends Retained earnings C. Income summary Dividends D. Dividends Income summary

30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000

Answer (A) is correct. Assuming an account entitled dividends or dividends declared is debited when dividends payable is credited on the declaration date, it must be closed at the end of the period. The balance in this account is closed directly to retained earnings. The effect of declaring and paying dividends is to reduce retained earnings, so the entry is a debit to retained earnings and a credit to dividends. Answer (B) is incorrect because the closing entry should credit dividends and debit retained earnings. Answer (C) is incorrect because dividends is closed directly to retained earnings. Answer (D) is incorrect because dividends is closed directly to retained earnings by a credit. [Fact Pattern #17]

An enterprise is in the equipment rental business. Part of its unadjusted trial balance at December 31 is as follows: Cash Prepaid insurance Property, plant, and equipment Accumulated depreciation Accounts payable Share capital Retained earnings Rental revenue Salaries and wages expense Utilities expense 17,400 3,600 180,000 32,000 12,000 60,000 38,000 171,000 80,000 14,000

On October 1, 20X4, the enterprise paid 18,000 to renew its only insurance policy for a 3-year period beginning on that date. This transaction has not been recorded. Salaries and wages of 1,700 have been incurred but not paid as of December 31, 20X4. At December 31, 20X4, the balance per bank statement was 12,000. Outstanding checks amounted to 6,900. Interest of 40 was credited to the enterprises account by the bank during December, but has not yet been entered on the books.

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[303] Gleim #: 3.13 -- Source: CIA 597 IV-4 (Refers to Fact Pattern #17) What amounts should be reported for prepaid insurance and insurance expense in the annual financial statements prepared at December 31?

Prepaid Insurance A. B. C. D. 16,500 16,500 18,000 20,100

Insurance Expense 1,500 5,100 3,600 1,500

Answer (A) is incorrect because the existing balance in the prepaid insurance account should be expensed. Answer (B) is correct. The insurance policy in effect at the beginning of the year expired and was renewed during the year. Hence, the entire 3,600 beginning balance in the prepaid insurance account should be expensed. The amount of the prepayment on the new policy to be expensed is 1,500 [3 months elapsed (18,000 36-month duration of the policy)]. The debit balance in prepaid insurance at year-end is therefore 16,500 (18,000 1,500), and total insurance expense is 5,100 (3,600 + 1,500). Answer (C) is incorrect because insurance expense should be recognized for the last 3 months of the year. Answer (D) is incorrect because prepaid insurance should be credited and insurance expense debited for 3,600. [304] Gleim #: 3.14 -- Source: CIA 597 IV-5 (Refers to Fact Pattern #17) The required adjusting entry at December 31 related to salaries and wages is

A. Salaries & wages expense Income summary B. Salaries & wages payable Salaries & wages expense C. Salaries & wages expense Salaries & wages payable D. Income summary Salaries & wages payable

1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700

Answer (A) is incorrect because the income summary account is used for closing entries, not adjusting entries. Answer (B) is incorrect because the entry shown is a reversing entry that could be made at the beginning of the subsequent period. Answer (C) is correct. An expense incurred but not yet paid is an accrued expense. The adjusting entry to record an accrued expense of 1,700 for unpaid salaries and wages is to debit an expense account and credit a liability account. Answer (D) is incorrect because the debit should be to an expense account. [305] Gleim #: 3.15 -- Source: CIA 597 IV-6 (Refers to Fact Pattern #17) The journal entry required to close the utilities expense account is

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A. Utilities expense Income summary B. Income summary Utilities expense C. Rental revenue Utilities expense D. Utilities expense Retained earnings

14,000 14,000 14,000 14,000 14,000 14,000 14,000 14,000

Answer (A) is incorrect because an expense account should be credited in a closing entry, and the income summary account should be debited. Answer (B) is correct. All income statement account balances are closed either to a summary account (such as income summary or revenue and expense summary) or to retained earnings. The normal balance of an expense account is a debit; therefore, an expense account is credited in a closing entry. Answer (C) is incorrect because an expense account should not be closed to a revenue account. Such offsetting is not good practice. Answer (D) is incorrect because an expense account should be credited in a closing entry. [306] Gleim #: 3.16 -- Source: CIA 1195 IV-4 Which of the following statements is the best description of reversing entries?

A. B. C. D.

The recording of reversing entries is a mandatory step in the accounting cycle. Reversing entries are made at the end of the next accounting period, after recording regular transactions of the period. Reversing entries are identical to the adjusting entries made in the previous period. Reversing entries are the exact opposite of the adjustments made in the previous period. Answer (A) is incorrect because reversing entries are optional. Answer (B) is incorrect because reversing entries are made at the beginning of the next accounting period. Answer (C) is incorrect because reversing entries are the exact opposite of the adjustments made in the previous period. Answer (D) is correct. Reversing entries are made at the beginning of a period to reverse the effects of adjusting entries made at the end of the preceding period. They are optional entries made for the sake of convenience in recording the transactions of the period. In order for reversing entries to reverse the prior adjustments, they must be the exact opposite of the adjustments made in the previous period.

[307] Gleim #: 3.17 -- Source: CIA 1195 IV-27 The practice of recording advance payments from customers as a liability is an example of applying the

A. B. C. D.

Going concern assumption. Monetary unit assumption. Historical cost principle. Revenue recognition principle.

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Answer (A) is incorrect because the going concern assumption is that the business will have an indefinite life. Answer (B) is incorrect because the monetary unit assumption is that money is the common denominator by which economic activity is conducted and that the monetary unit provides an appropriate basis for accounting measurement and analysis. Answer (C) is incorrect because the historical cost principle reflects the practice that many assets and liabilities are accounted for and reported on the basis of acquisition price. Answer (D) is correct. Recognition of revenue occurs when the flow of future economic benefits to the enterprise is probable and such benefits are reliably measurable. Recording advance payments as a liability reflects a determination that the receipt of future economic benefits is not sufficiently certain to merit revenue recognition, given that the enterprise has not yet performed its obligations. [308] Gleim #: 3.18 -- Source: CIA 1194 IV-24 An entity sells a durable good to a customer on January 1, 20X3, and the customer is automatically given a 1-year warranty. The customer also buys an extended warranty package, extending the coverage for an additional 2 years to the end of 20X5. At the time of the original sale, the company expects warranty costs to be incurred evenly over the life of the warranty contracts. The customer has only one warranty claim during the 3-year period, and the claim occurs during 20X4. The company will recognize income from the sale of the extended warranty

A. B. C. D.

On January 1, 20X3. In years 20X4 and 20X5. At the time of the claim in 20X4. December 31, 20X5, when the warranty expires. Answer (A) is incorrect because the recognition of income from the sale of the extended warranty is deferred until the extended warranty period begins. Answer (B) is correct. Because warranty costs are expected to be incurred evenly over the life of the warranty contracts, the income should be recognized on the straight-line basis over the life of the extended warranty contract. Answer (C) is incorrect because the income should be recognized evenly over the life of the contract. It is not related to the timing of the claims. Answer (D) is incorrect because income is recognized over the life of the warranty, not at expiration.

[309] Gleim #: 3.19 -- Source: CIA 596 IV-4 An entity had cash receipts from sales of 175,000 during 20X4, of which 30,000 was unearned at the end of 20X4. At the end of 20X3, the company had 40,000 of unearned revenue, all of which was earned in 20X4. The companys sales revenue for 20X4 would be

A. B. C. D.

145,000 165,000 175,000 185,000 Answer (A) is incorrect because 145,000 equals 20X4 revenue from 20X4 sales. Answer (B) is incorrect because 165,000 adds, rather than subtracts, the 20X4 unearned revenue and subtracts, rather than adds, the 20X3 receipts for which revenue was earned in 20X4. Answer (C) is incorrect because 175,000 equals the cash receipts for 20X4. Answer (D) is correct. The sales revenue earned in 20X4 equals 20X4 cash receipts, minus any receipts in 20X4 for which the revenue has not yet been earned, plus the revenue earned from cash receipts in 20X3, or 185,000 (175,000 30,000 + 40,000).

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[310] Gleim #: 3.20 -- Source: CIA 590 IV-26 ABC operates a catering service that specializes in business luncheons for large corporations. ABC requires customers to place their orders 2 weeks in advance of the scheduled events. ABC bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, ABC should recognize revenue from its catering services at the date when a

A. B. C. D.

Customer places an order. Luncheon is served. Billing is mailed. Customers payment is received. Answer (A) is incorrect because the certainty and measurability criteria are not met when the customer places an order. Answer (B) is correct. Income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably. The most common time at which these two conditions are met is when the product or merchandise is delivered or services are rendered to customers. Thus, the entity has substantially accomplished what it must do to be entitled to future economic benefits when it serves the luncheon. It should then accrue a receivable and revenue. Answer (C) is incorrect because the date for billing is a matter of administrative procedure and convenience. The revenue should be recognized at the date the service was performed. Answer (D) is incorrect because the revenue should be recognized at the point of performance of the service. To wait until the receivable is collected is to ignore the accrual basis of accounting, which is identified in the Framework for the Preparation and Presentation of Financial Statements as an underlying assumption of financial accounting.

[311] Gleim #: 3.21 -- Source: CIA 595 IV-11 If sales are accounted for using the installment method, which of the following is(are) only recognized in proportion to the cash collected on the sales during the period?

A. B. C. D.

Sales. Sales and cost of sales. Sales and cost of sales and selling expenses. Sales and cost of sales and administrative expenses. Answer (A) is incorrect because sales and cost of sales are recognized in proportion to cash collections. Answer (B) is correct. Under the installment method, the gross profit on sales (sales cost of sales) is not recognized until cash is collected. The proportion of cash collected on the sales during the accounting period determines the proportion of the gross profit on those sales that is recognized during the period. Hence, both sales and cost of sales are deferred. Answer (C) is incorrect because only the gross profit is deferred on sales for which cash has not yet been collected. Answer (D) is incorrect because only the gross profit is deferred on sales for which cash has not yet been collected.

[312] Gleim #: 3.22 -- Source: CIA 597 IV-10 Using the cost-recovery method of revenue recognition, profit on an installment sale is recognized

A. B. C. D.

On the date of the installment sale. In proportion to the cash collections. After cash collections equal to the cost of goods sold have been received. On the date the final cash collection is received.

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Answer (A) is incorrect because the accrual basis recognizes revenue on the date of the installment sale. Answer (B) is incorrect because the installment basis recognizes revenue in proportion to the cash collections. Answer (C) is correct. Under the cost-recovery method, no revenue is recognized until cash payments by the buyer exceed the sellers cost of the merchandise sold. This method is appropriate when collection of the revenue is very uncertain. Answer (D) is incorrect because, after the cash collections equal the cost of sales, revenue is to be recognized for any further collections. [313] Gleim #: 3.23 -- Source: CIA 1190 IV-28 On February 1, year 1 a computer software firm agrees to program a software package. Twelve payments of 10,000 on the first of each month are to be made, with the first payment March 1, year 1. The software is accepted by the client June 1, year 2. How much year 1 revenue should be recognized?

A. B. C. D.

0 100,000 110,000 120,000 Answer (A) is correct. Recognition of an element of financial statements (e.g., income, which includes revenue and gains) requires that two criteria be met. It must be probable that any future economic benefit associated with the item will flow to or from the entity, and the cost or value of the item must be measurable with reliability. The usual procedures for income recognition, e.g., that income be earned, reflect these criteria. Thus, income is recognized when an increase in future economic benefits is associated with an increase in an asset or a decrease in a liability. However, the entity has not substantially completed what it must do to be entitled to the benefits represented by the advance payment, and the receipt of future economic benefits is not sufficiently certain to merit income recognition. Accordingly, a liability should be recognized because the entity has a current obligation arising from a past event that will require an outflow of economic benefits, that is, to deliver the software or to refund the customers money. Thus, a liability for 100,000 and revenue of 0 should be recognized for year 1. NOTE: This analysis assumes that the sale of the software is a sale either of goods or of services for which the appropriate conditions have not been met. Under IAS 18, Revenue Recognition, revenue is recognized for a sale of goods when the entity has transferred the significant risks and rewards of ownership, the entity has neither continuing managerial involvement to an extent associated with ownership nor effective control over the goods, the amount can be reliably measured, it is probable that the economic benefits will flow to the entity, and transaction costs can be reliably measured. For a sale of services, revenue is recognized when revenue can be reliably measured, it is probable that the economic benefits will flow to the entity, the stage of completion can be reliably measured, and the costs incurred and the costs to complete can be reliably measured. Answer (B) is incorrect because income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably. Answer (C) is incorrect because income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably. Answer (D) is incorrect because income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably.

[314] Gleim #: 3.24 -- Source: CIA 1193 IV-28 A building contractor has a fixed-price contract to construct a large building. It is estimated that the building will take 2 years to complete. Progress billings will be sent to the customer at quarterly intervals. Which of the following describes the preferable point for revenue recognition for this contract if the outcome of the contract can be estimated reliably?

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A. B. C. D.

After the contract is signed. As progress is made toward completion of the contract. As cash is received. When the contract is completed. Answer (A) is incorrect because revenue is not recognized until progress has been made toward completion. Answer (B) is correct. Under the percentage-of-completion method, revenues and expenses are recognized based on the stage of completion at the balance sheet date if the outcome of the contract can be estimated reliably. For a fixed-price contract, the outcome can be estimated reliably if (1) total revenue can be measured reliably, (2) it is probable that the economic benefits of the contract will flow to the enterprise, (3) contract costs to complete and stage of completion can be measured reliably, and (4) contract costs can be clearly identified and measured reliably so that actual and estimated costs can be compared. Answer (C) is incorrect because the cash basis is inappropriate. An accrual method, that is, the percentage-of-completion method, should be used. Answer (D) is incorrect because the completed-contract method is not a permissible method.

[315] Gleim #: 3.25 -- Source: CIA 590 IV-32 The major distinction between the multiple-step and single-step income statement formats is the separation of

A. B. C. D.

Operating and nonoperating data. Income tax expense and administrative expenses. Cost of goods sold expense and administrative expenses. The effect on income taxes of extraordinary items and the effect on income taxes of profit or loss from ordinary activities. Answer (A) is correct. The IASs do not require a particular income statement format, although, at a minimum, certain line items must be presented. The single-step income statement provides one grouping for income items and one for expense items. The single step is the one subtraction necessary to arrive at net profit or loss. The multiple-step income statement matches operating income and expenses separately from nonoperating items. Answer (B) is incorrect because both formats separate income tax expense and administrative expenses. Answer (C) is incorrect because both formats separate cost of goods sold expense and administrative expenses. Answer (D) is incorrect because intraperiod income tax allocation procedures must be applied to both formats. Extraordinary items are not reported.

[316] Gleim #: 3.26 -- Source: CIA 1196 IV-5 At January 1, year 1, a sole proprietorships assets totaled 210,000, and its liabilities amounted to 120,000. During year 1, owner investments amounted to 72,000, and owner withdrawals totaled 75,000. At December 31, year 1, assets totaled 270,000, and liabilities amounted to 171,000. The amount of net profit for year 1 was

A. B. C. D.

0 6,000 9,000 12,000

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Answer (A) is incorrect because the enterprise did have a net profit. Answer (B) is incorrect because 6,000 mistakenly deducts the 72,000 and adds the 75,000. Answer (C) is incorrect because 9,000 is the difference between beginning and ending equity without taking into consideration the capital transactions with, and distributions to, the owner. Answer (D) is correct. Net profit or loss may be derived using the basic accounting equation (assets = liabilities + equity). Equity at 1/1/year 1 was 90,000 (210,000 of assets 120,000 of liabilities). Equity at 12/31/year 1 was 99,000 (270,000 171,000). Because owner transactions decreased net assets by 3,000 (72,000 investment 75,000 withdrawals), net profit must have been 12,000 [99,000 (90,000 3,000)]. [317] Gleim #: 3.27 -- Source: CIA 596 IV-44 An entity has a 50% gross margin, general and administrative expenses of 50, interest expense of 20, and net profit of 10 for the year just ended. If the corporate tax rate is 50%, the level of sales for the year just ended was

A. B. C. D.

90 135 150 180 Answer (A) is incorrect because 90 is the gross margin. Answer (B) is incorrect because 135 is 150% of the gross margin. Answer (C) is incorrect because 150 assumes profit before tax equals 50% of net profit. Answer (D) is correct. Net profit equals sales minus cost of sales, G&A expenses, interest, and tax. Given a 50% tax rate, profit before tax must have been 20 [10 net profit (1.0 .5 tax rate)]. Accordingly, profit before interest and tax must have been 40 (20 profit before tax + 20 interest), and the gross margin (sales cost of sales) must have been 90 (40 profit before interest and tax + 50 G&A expenses). If the gross margin is 50% of sales, sales equals 180 (90 gross margin .5).

[318] Gleim #: 3.28 -- Source: CIA 1193 IV-33 Which combination below explains the impact of credit card interest incurred and paid during the period on (1) equity on the balance sheet and (2) the statement of cash flows?

(1) Effect on Equity on Balance Sheet A. B. C. D. Decrease Decrease No effect No effect

(2) Reflected on Statement of Cash Flows as a(n) Investing outflow Operating or financing outflow Financing or investing outflow Operating outflow

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Answer (A) is incorrect because interest payments are classified as an operating or financing outflow on the statement of cash flows. Answer (B) is correct. Interest incurred is classified as interest expense on the income statement, which in turn reduces equity on the balance sheet by reducing retained earnings. According to IAS 7, cash payments for interest made by an enterprise that is not a financial institution may be classified on the statement of cash flows as an outflow of cash from operating or financing activities. Answer (C) is incorrect because credit card interest charges reduce equity. Answer (D) is incorrect because credit card interest charges reduce equity. [319] Gleim #: 3.29 -- Source: CIA 1192 IV-32 A reader of a statement of cash flows wishes to analyze the major classes of gross cash receipts and gross cash payments from operating activities. Which methods of reporting cash flows from operating activities will supply that information?

A. B. C. D.

Both the direct and indirect methods. Only the direct method. Only the indirect method. Neither method. Answer (A) is incorrect because only the direct method supplies information about major classes of gross cash receipts and payments related to operating activities. Answer (B) is correct. The statement of cash flows may report cash flows from operating activities in either an indirect or a direct format. The direct format reports the major classes of operating cash receipts and cash payments as gross amounts. The indirect presentation adjusts net profit or loss to the same amount of net cash from operating activities that would be determined in accordance with the direct method. To arrive at this amount, the indirect method adjusts net profit or loss for the effects of noncash transactions, deferrals or accruals of past or future operating cash flows, and income or expense related to financing or investing activities. Answer (C) is incorrect because the direct method, rather than the indirect method, supplies information about major classes of gross cash receipts and payments related to operating activities. Answer (D) is incorrect because the direct method reports major classes of gross cash receipts and payments from operating activities.

[320] Gleim #: 3.30 -- Source: CIA 1195 IV-34 In the statement of cash flows, the payment of cash dividends appears in the <List A> activities section as a <List B> of cash.

List A A. B. C. D. Operating or investing Operating or financing Investing or financing Investing

List B Source Use Use Source

Answer (A) is incorrect because payment of cash dividends is a use of cash for an operating or financing activity. Answer (B) is correct. According to IAS 7, dividends paid may be treated as a cash outflow from financing activities because they are a cost of obtaining resources from owners. However, they may also be treated as operating items to help determine the enterprises ability to pay dividends from operating cash flows. Answer (C) is incorrect because payment of cash dividends is a use of cash for an operating or financing activity. Answer (D) is incorrect because payment of cash dividends is a use of cash for an operating or financing activity.

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[321] Gleim #: 3.31 -- Source: CIA 596 IV-10 The comparative balance sheet for an enterprise that had net profit of 150,000 for the year ended December 31, 20X4, and paid 125,000 of dividends during 20X4 is as follows: 12/31/X4 Cash Accounts receivable Total assets Payables Share capital Retained earnings Total 150,000 200,000 350,000 80,000 130,000 140,000 350,000 12/31/X3 180,000 220,000 400,000 160,000 125,000 115,000 400,000

If dividends paid are treated as a cost of obtaining financial resources, the amount of net cash from operating activities during 20X4 was

A. B. C. D.

70,000 90,000 150,000 210,000 Answer (A) is incorrect because 70,000 fails to add to net profit the reduction in accounts receivable. Answer (B) is correct. Net profit is adjusted to determine the net cash from operations. The payment of cash dividends is regarded as a cash flow from a financing activity. Hence, it is not a reconciling item. However, the decrease in accounts receivable (220,000 200,000 = 20,000) during the period represents a cash inflow (collections of pre-20X4 receivables) not reflected in 20X4 net profit. Moreover, the decrease in payables (160,000 80,000 = 80,000) indicates a cash outflow (payment of pre-20X4 liabilities) that also is not reflected in 20X4 net income. Accordingly, net cash from operations was 90,000 (150,000 + 20,000 80,000). Answer (C) is incorrect because 150,000 is net profit. Answer (D) is incorrect because 210,000 subtracts the reduction in receivables and adds the reduction in payables.

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[Fact Pattern #18] Balance sheets on December 31, year 1 and December 31, year 2 are presented below:

Dec. 31, year 1 Assets: Cash Accounts receivable Allowance for uncollectible accounts Inventory Property, plant, and equipment Accumulated depreciation Total Assets 50,000 95,000

Dec. 31, year 2 60,000 89,000

Liabilities and Equity: Trade accounts payable Interest payable Bonds payable Unamortized bond discount Equity Total Liabilities and Equity Additional information for year 1:

62,000 8,000 200,000 (15,000) 199,000 454,000

49,000 11,000 200,000 (10,000) 257,000 507,000

(4,000) 120,000 295,000 (102,000) 454,000

(3,000) 140,000 340,000 (119,000) 507,000

1. Cash payments to suppliers of merchandise were 180,000. 2. Sales revenue was 338,000. 3. 3,000 of accounts receivable was written off. 4. Equipment was acquired for 65,000. 5. Depreciation expense was 30,000. 6. Interest expense was 20,000.

[322] Gleim #: 3.32 -- Source: CIA 1196 IV-13 (Refers to Fact Pattern #18) Cost of goods sold in year 2 was

A. B. C. D.

147,000 160,000 167,000 180,000 Answer (A) is correct. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. To determine cost of goods sold, purchases must be calculated. Purchases equal 167,000 (49,000 ending accounts payable + 180,000 payments to suppliers 62,000 beginning accounts payable). Thus, cost of goods sold equals 147,000 (120,000 beginning inventory + 167,000 purchases 140,000 ending inventory). Answer (B) is incorrect because 160,000 results from assuming that 180,000 of cash payments to suppliers equaled purchases. Answer (C) is incorrect because 167,000 equals purchases. Answer (D) is incorrect because 180,000 is the amount of cash payments to suppliers.

[323] Gleim #: 3.33 -- Source: CIA 1196 IV-14 (Refers to Fact Pattern #18) Cash collections from customers in year 2 were

A. B. C. D.

341,000 338,000 344,000 335,000

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Answer (A) is correct. Cash collections from customers equals beginning accounts receivable, plus sales revenue, minus accounts written off, minus ending accounts receivable. In year 2, cash collections from customers were 341,000 (95,000 + 338,000 3,000 89,000). Answer (B) is incorrect because 338,000 is the sales revenue for the year. Answer (C) is incorrect because 344,000 includes the 3,000 of accounts written off. Answer (D) is incorrect because 335,000 is sales revenue minus accounts written off. [324] Gleim #: 3.34 -- Source: CIA 1196 IV-15 (Refers to Fact Pattern #18) The carrying amount (cost minus accumulated depreciation) of property, plant, and equipment disposed of in year 2 was

A. B. C. D.

7,000 17,000 20,000 32,000 Answer (A) is correct. The cost of PPE disposed of is 20,000 (295,000 beginning PPE + 65,000 acquisitions 340,000 ending PPE). The accumulated depreciation is 13,000 (102,000 beginning accumulated depreciation + 30,000 depreciation expense 119,000 ending accumulated depreciation). Thus, the carrying amount of PPE disposed of is 7,000 (20,000 cost of PPE 13,000 accumulated depreciation). Answer (B) is incorrect because 17,000 is the difference between ending and beginning accumulated depreciation. Answer (C) is incorrect because 20,000 is the cost of the PPE disposed. Answer (D) is incorrect because 32,000 results from using the change in the PPE account without acquisitions minus the accumulated depreciation.

[325] Gleim #: 3.35 -- Source: CIA 1196 IV-16 (Refers to Fact Pattern #18) Cash interest payments in year 2 were

A. B. C. D.

8,000 12,000 20,000 25,000 Answer (A) is incorrect because 8,000 is the beginning interest payable. Answer (B) is correct. The interest payable credited in year 1 was 15,000 (20,000 interest expense 5,000 amortized bond discount). Thus, the cash interest payment was 12,000 (8,000 beginning interest payable + 15,000 interest payable credited in year 1 11,000 ending interest payable). Answer (C) is incorrect because 20,000 is the interest expense for year 1. Answer (D) is incorrect because 25,000 is the interest expense plus the amortized discount.

[326] Gleim #: 3.36 -- Source: CIA 595 IV-2 In the determination of cost of goods sold, <List A> must be <List B> cash payments for goods along with other adjustments.

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List A A. B. C. D. An increase in accounts payable A decrease in accounts payable An increase in inventory A decrease in inventory

List B Added to Added to Added to Subtracted from

Answer (A) is correct. To convert from the cash basis (cash payments) to the accrual basis (cost of goods sold), an increase in accounts payable must be added to cash payments for goods to determine net purchases. Net purchases is then adjusted for the change in inventory to determine cost of goods sold. Answer (B) is incorrect because a decrease in accounts payable must be subtracted from, not added to, cash payments. Answer (C) is incorrect because an increase in inventory must be subtracted from, not added to, cash payments to calculate cost of goods sold. Answer (D) is incorrect because a decrease in inventory must be added to, not subtracted from, cash payments to calculate cost of goods sold. [327] Gleim #: 3.37 -- Source: CIA 1196 IV-1 A corporation reported salaries expense of 190,000 for December of the current year. The following data are from its records: Dec. 31 Prepaid salaries Salaries payable 46,000 170,000 Nov. 30 40,000 140,000

The amount of cash payments for salaries during December of the current year was

A. B. C. D.

154,000 166,000 214,000 226,000 Answer (A) is incorrect because 154,000 subtracts the 6,000 increase in prepaid salaries instead of adding it. Answer (B) is correct. An increase in prepaid salaries indicates that salaries expense is less than the cash paid for salaries. An increase in salaries payable indicates that salaries expense is more than the cash paid for salaries. Thus, the amount of cash payments for salaries was 166,000 (190,000 salaries expense + 6,000 increase in prepaid salaries 30,000 increase in salaries payable). Answer (C) is incorrect because 214,000 subtracts the increase in prepaid salaries instead of adding it and adds the 30,000 increase in salaries payable instead of subtracting it. Answer (D) is incorrect because 226,000 adds the 30,000 increase in salaries payable instead of subtracting it.

[328] Gleim #: 3.38 -- Source: CIA 593 IV-44 In reconciling net profit on an accrual basis to net cash from operating activities, what adjustment is needed to net profit because of (1) an increase during the period in prepaid expenses and (2) the periodic amortization of premium on bonds payable?

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(1) Increase in Prepaid Expenses A. B. C. D. Add Add Deduct Deduct

(2) Amortization of Premium on Bonds Payable Add Deduct Add Deduct

Answer (A) is incorrect because the increase in prepaid expenses requires a deduction from net profit in the reconciliation. Answer (B) is incorrect because the increase in prepaid expenses requires a deduction from net profit in the reconciliation. Answer (C) is incorrect because amortization of premium on bonds payable requires a deduction from net profit in the reconciliation. Answer (D) is correct. An increase in prepaid expenses indicates that cash outlays for expenses exceeded the related expense incurred; thus, net profit exceeded net cash from operating activities, and a deduction is needed in the reconciliation. Also, the amortization of premium on bonds payable causes a reduction of interest expense but does not increase cash; therefore, net profit exceeds net cash from operating activities, and a deduction is needed in the reconciliation. [329] Gleim #: 3.39 -- Source: CIA 1193 IV-34 An entity has publicly announced a detailed, formal plan to dispose in its entirety of a component of the entity that represents a separate major line of business that is distinct operationally and financially. Which of the following is the proper treatment of the disclosures that should be made after the announcement?

A. B. C. D.

As part of continuing operations. As a discontinued operation. As an extraordinary item. As a prior-period item. Answer (A) is incorrect because the component is to be terminated (discontinued). Answer (B) is correct. A separate major line of business or geographical operating area that is distinct for operational and reporting purposes is a component of an entity. Thus, its disposal qualifies to be reported. Answer (C) is incorrect because extraordinary items are not reported in the financial statements or notes. They are not clearly distinct from ordinary activities. Answer (D) is incorrect because disclosures begin with the current period, i.e., when the criteria for classification of the DO as held for sale are met.

[330] Gleim #: 3.40 -- Source: CIA 591 IV-38 Which of the following is a unique reporting problem associated with the determination of the results of operations for an interim period?

A. Advertising and similar costs expensed in one interim period may benefit other interim periods in the same annual period. B. Cost of goods sold for an interim period reflects only the amount of product cost applicable to sales revenue recognized in the interim period. C. Depreciation for an interim period represents an estimate. D. An extraordinary loss occurring in the second quarter must be prorated over the last three interim periods of the year.

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Answer (A) is correct. Costs and expenses other than product costs should be either charged to income in interim periods as incurred or allocated among interim periods based upon the benefits received. Accordingly, costs such as advertising should be deferred in an interim period if the benefits extend beyond that period; otherwise, they should be expensed as incurred. But such a determination is difficult, and deferral raises the additional issue of how the deferred costs should be allocated among quarters. Thus, many entities expense the costs as incurred even though they may benefit other interim periods in the same annual period. Answer (B) is incorrect because the only product costs appropriate to expense in an interim period are the ones related to the revenue transactions recognized in the same interim period. Answer (C) is incorrect because the annual depreciation amount is an estimate. The depreciation amount for an interim period is simply a pro rata amount of the annual estimate. Answer (D) is incorrect because extraordinary items are not reported in interim or annual statements. [331] Gleim #: 3.41 -- Source: CIA 1188 IV-33 The following data were extracted from the financial statements of a company for the year ended December 31. Net profit Depreciation expense Amortization of intangibles Decrease in accounts receivable Increase in inventories Increase in accounts payable Increase in plant assets Increase in share capital Decrease in short-term notes payable 70,000 14,000 1,000 2,000 9,000 4,000 47,000 31,000 55,000

There were no disposals of plant assets during the year. Based on the information above, a statement of cash flows will report a net increase in cash of

A. B. C. D.

11,000 17,000 54,000 69,000 Answer (A) is correct. Depreciation and amortization are noncash expenses and are added to net profit. A decrease in receivables indicates that cash collections exceed sales on an accrual basis, so it is added to net profit. To account for the difference between cost of goods sold (a deduction from net profit) and cash paid to suppliers, a two-step adjustment of net profit is necessary. The difference between CGS and purchases is the change in inventory. The difference between purchases and the amount paid to suppliers is the change in accounts payable. Accordingly, the conversion of CGS to cash paid to suppliers requires deducting the inventory increase and adding the accounts payable increase. An increase in plant assets indicates an acquisition of plant assets, causing a decrease in cash, so it is deducted. An increase in share capital represents a cash inflow and is added to net profit. A decrease in short-term notes payable is deducted from net profit because it reflects a cash outflow. Thus, cash increased by 11,000 (70,000 net profit + 14,000 + 1,000 + 2,000 9,000 + 4,000 47,000 + 31,000 55,000). Answer (B) is incorrect because 17,000 results from subtracting the amortization and the decrease in receivables and adding the increase in inventories. Answer (C) is incorrect because 54,000 results from adjusting net profit for the increase in plant assets and the increase in share capital only. Answer (D) is incorrect because 69,000 results from failing to make the adjustments for receivables, inventories, notes payable, and accounts payable.

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[332] Gleim #: 3.42 -- Source: CIA 1192 IV-26 A newly acquired plant asset is to be depreciated over its useful life. The rationale for this process is the

A. B. C. D.

Economic entity assumption. Monetary unit assumption. Materiality assumption. Going concern assumption. Answer (A) is incorrect because the economic entity assumption provides that economic activity can be identified with a particular unit of accountability. Answer (B) is incorrect because the monetary unit assumption provides that all transactions and events can be measured in terms of a common denominator, for instance, the euro. Answer (C) is incorrect because the materiality assumption simply implies that items of insignificant value may be expensed rather than capitalized and depreciated or amortized. The difference in treatment is not large enough to influence users if the item is not material. Answer (D) is correct. A basic feature of financial accounting is that the entity is assumed to be a going concern in the absence of evidence to the contrary. The going concern concept is based on the empirical observation that many entities have an indefinite life. The reporting entity is assumed to have a life long enough to fulfill its objectives and commitments and therefore to depreciate wasting assets over their useful lives.

[333] Gleim #: 3.43 -- Source: CIA 590 IV-35 Assuming all of the following involve material amounts, which is most likely to be classified as an extraordinary item in the income statement?

A. B. C. D.

A loss because of an expropriation of assets by a foreign government. A loss because of adjustments of accruals on long-term contracts. A gain because of the disposal of assets associated with a discontinuing operation of a business. None of the above. Answer (A) is incorrect because no items described as extraordinary are not presented on the face of the income statement or in the notes. Answer (B) is incorrect because no items described as extraordinary are not presented on the face of the income statement or in the notes. Answer (C) is incorrect because no items described as extraordinary are not presented on the face of the income statement or in the notes. Answer (D) is correct. According to IAS 1, An entity shall not present any items of income and expense as extraordinary items, either on the face of the income statement or in the notes.

[334] Gleim #: 3.44 -- Source: CIA 1191 IV-42 An extraordinary gain occurs in the second fiscal quarter. How should the gain be accounted for?

A. B. C. D.

Recognized in full in the second quarter. Recognized equally over the second, third, and fourth quarters. Recognized only in the annual financial statements. Recognized equally in each quarter, by restating the first quarter.

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Answer (A) is correct. Gains and losses similar to those that would not be deferred at year-end should not be deferred to later interim periods of the same year. Hence, the extraordinary gain should not be prorated. However, no items of income or expense are presented as extraordinary on the income statement or in the notes. Answer (B) is incorrect because the gain should be recognized in full in the second quarter. Answer (C) is incorrect because the gain should be recognized in full in the second quarter. Answer (D) is incorrect because the gain should be recognized in full in the second quarter. [335] Gleim #: 3.45 -- Source: CIA 1191 IV-34 An entity offers its customers credit terms of a 2% discount if paid within 10 days, or the full balance is due within 30 days (2/10, n/30). If some customers take advantage of the cash discount and others do not, which of the following accounts will appear on the income statement if the net method of recording receivables is employed?

Sales Discounts Sales Discounts A. B. C. D. Yes Yes No No Forfeited Yes No No Yes

Answer (A) is incorrect because the net method requires a sales discount forfeited but not a sales discount account. Answer (B) is incorrect because the net method requires a sales discount forfeited but not a sales discount account. Answer (C) is incorrect because the net method requires a sales discount forfeited. Answer (D) is correct. The gross method accounts for receivables at their face amount. If a discount is taken, a sales discount is recorded and classified as an offset to sales in the income statement to yield net sales. The net method records receivables net of the applicable discount. If the payment is not received during the discount period, an interest revenue account, such as sales discounts forfeited, is credited at the end of the discount period or when the payment is received. Accordingly, the application of the net method requires a sales discount forfeited but not a sales discount account. [336] Gleim #: 3.46 -- Source: CIA 1193 IV-41 An internal auditor is deriving cash flow data based on an incomplete set of facts. Bad debt expense was 2,000. Additional data for this period follows: Net sales Accounts receivable beginning balance Allowance for bad debts beginning balance Accounts receivable written off Increase in net accounts receivable (after subtraction of allowance for bad debts) 100,000 5,000 (500) 1,000 30,000

How much cash was collected this period?

A. B. C. D.

67,000 68,500 68,000 70,000

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Answer (A) is incorrect because 67,000 results from subtracting the write-offs and the bad debt expense from the sum of net income and beginning net accounts receivable. Answer (B) is incorrect because 68,500 assumes a zero balance in the beginning allowance account and deducts bad debt expense from the sum of net profit and beginning net accounts receivable. Answer (C) is incorrect because 68,000 deducts bad debt expense from the sum of net profit and beginning net accounts receivable. Answer (D) is correct. The cash collected equals net sales adjusted for the change in net accounts receivable (gross A/R allowance for bad debts). An increase in net accounts receivable implies that cash collected was less than net sales. Hence, cash collected was 70,000 (100,000 30,000 increase in net A/R). Write-offs (debit the allowance, credit A/R) do not affect the computation of cash collected because the allowance and gross accounts receivable are reduced by the same amount. Moreover, recognition of bad debt expense (debit bad debt expense, credit the allowance) is not included in this calculation because it is already reflected in the net accounts receivable balance. [337] Gleim #: 3.47 -- Source: CIA 1196 IV-33 An analysis of an entitys 150,000 accounts receivable at year-end resulted in a 5,000 ending balance for its allowance for uncollectible accounts and a bad debt expense of 2,000. During the past year, recoveries on bad debts previously written off were correctly recorded at 500. If the beginning balance in the allowance for uncollectible accounts was 4,700, what was the amount of accounts receivable written off as uncollectible during the year?

A. B. C. D.

1,200 1,800 2,200 2,800 Answer (A) is incorrect because 1,200 results from subtracting the recoveries instead of adding them. Answer (B) is incorrect because 1,800 results from subtracting bad debt expense from the allowance account. Answer (C) is correct. Under the allowance method, uncollectible accounts are written off by a debit to the allowance account and a credit to accounts receivable. The 500 of recovered bad debts is accounted for by a debit to accounts receivable and a credit to the allowance account. The 2,000 bad debt expense is also credited to the allowance account. The amount of accounts receivable written off as uncollectible is 2,200 [5,000 ending allowance (4,700 beginning allowance + 500 recoveries + 2,000 bad debt expense)]. Answer (D) is incorrect because 2,800 results from subtracting the recoveries and bad debt expense from the allowance account.

[Fact Pattern #19] An entity sells goods on an installment basis. The table below includes information about the level of installment sales, the cost of the goods sold on installment, and the cash receipts on installment sales for 20X3 through 20X5. All cash receipt amounts shown are net of any interest charges.

20X3 Installment sales Cost of installment sales Cash receipts on 20X3 sales Cash receipts on 20X4 sales Cash receipts on 20X5 sales

20X4

20X5

10,000 5,000 20,000 6,000 4,000 10,000 2,000 4,000 1,000 4,000 2,000 4,000

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[338] Gleim #: 3.48 -- Source: CIA 596 IV-1 (Refers to Fact Pattern #19) The rate of gross profit on 20X4 installment sales is

A. B. C. D.

20% 40% 50% 80% Answer (A) is correct. The rate of gross profit on 20X4 installment sales is 20% [(5,000 of 20X4 installment sales 4,000 cost of 20X4 installment sales) 5,000 of 20X4 installment sales]. Answer (B) is incorrect because 40% is the gross profit on 20X3 installment sales. Answer (C) is incorrect because 50% is the gross profit on 20X5 installment sales. Answer (D) is incorrect because 80% is the ratio of the cost of 20X4 installment sales to 20X4 installment sales.

[339] Gleim #: 3.49 -- Source: CIA 596 IV-2 (Refers to Fact Pattern #19) The amount of gross profit to be recognized in 20X3 on 20X3 installment sales is

A. B. C. D.

800 2,000 3,200 4,000 Answer (A) is correct. In 20X3, cash receipts were 2,000 from 20X3 installment sales. The gross profit realized is the gross profit on the portion of sales for which payment has been received. This amount equals the 20X3 gross profit percentage multiplied by the cash receipts, or 800 {[(10,000 6,000) 10,000] 2,000}. Answer (B) is incorrect because 2,000 is the amount of cash receipts during 20X3 on 20X3 installment sales. Answer (C) is incorrect because 3,200 is the amount of the total gross profit on 20X3 installment sales that is deferred to future periods. Answer (D) is incorrect because 4,000 is the total gross profit on 20X3 installment sales.

[340] Gleim #: 3.50 -- Source: CIA 596 IV-3 (Refers to Fact Pattern #19) The gross profit amount from 20X5 sales to be deferred to future years would be

A. B. C. D.

2,000 3,000 8,000 10,000 Answer (A) is incorrect because 2,000 is the realized gross profit on 20X5 sales. Answer (B) is incorrect because 3,000 equals total receipts for 20X4 and 20X5 on 20X4 sales. Answer (C) is correct. The total gross profit on 20X5 sales is 10,000 (20,000 sales 10,000 cost), and the amount realized is 2,000 {[(20,000 10,000) 20,000] 4,000 of 20X5 cash receipts}. Accordingly, the amount deferred is 8,000 (10,000 2,000). Answer (D) is incorrect because 10,000 is the total gross profit on 20X5 sales.

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[341] Gleim #: 3.51 -- Source: CIA 1196 IV-42 At the end of September, an entity has outstanding accounts receivable of 350 on third-quarter credit sales, composed as follows: Still Outstanding at the End of September 100 170 80

Month July August September

Credit Sales 600 900 500

The percentage of receivables in the 31-to-60-day age group at the end of September is

A. B. C. D.

22.86% 28.57% 48.57% 71.43% Answer (A) is incorrect because 22.86% is the proportion of receivables in the 0-to-30-day age group at the end of September. Answer (B) is incorrect because 28.57% is the proportion of receivables in the 61-to-90-day age group at the end of September. Answer (C) is correct. Receivables from August sales still outstanding at the end of September are in the 31-to-60-day age group. This group represents 48.57% of total receivables [170 (100 + 170 + 80)]. Answer (D) is incorrect because 71.43% is the proportion of outstanding receivables that are from 0 to 60 days old at the end of September.

[342] Gleim #: 3.52 -- Source: CIA 595 IV-12 An entity sells inventory for 80,000 that had an inventory cost of 40,000. The terms of the sale involve payments receivable of 10,000 in the first year, 45,000 in the second year, and 25,000 in the third year. The buyer of the inventory is a new firm with no credit history. If the cost-recovery method of revenue recognition is used, the amount of gross profit to be recognized in the second year is

A. B. C. D.

0 5,000 15,000 45,000 Answer (A) is incorrect because, under the cost-recovery method, profit is recognized in the second year when cash payments by the buyer exceed the sellers cost of merchandise. Answer (B) is incorrect because 5,000 is the profit to be recognized without consideration of the payment received in the first year. Answer (C) is correct. The profit recognized in the second year equals the cumulative payments received minus the sellers cost, or 15,000 [(10,000 + 45,000) 40,000]. Answer (D) is incorrect because 45,000 is the payment received in the second year.

[343] Gleim #: 3.53 -- Source: CIA 1195 IV-15 When a right of return exists, an entity may recognize revenue from a sale of goods at the time of sale only if

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A. B. C. D.

The amount of future returns can be reliably estimated. The seller retains the risks and rewards of ownership. The buyer resells the goods. The seller believes returns will not be material. Answer (A) is correct. One condition for recognition of revenue from the sale of goods is the transfer of the significant risks and rewards of ownership. Retention of significant risk may occur when, for example, the buyer may rescind the purchase for a reason stipulated in the contract, and the buyer is uncertain about the probability of return. However, if the entity can reliably estimate future returns and recognizes a liability for returns based on experience and other pertinent information, revenue may be recognized at the time of sale if the other conditions for revenue recognition are also met. Answer (B) is incorrect because the risks and rewards of ownership must be transferred. Answer (C) is incorrect because this contingency is an example of retention of significant risk. Answer (D) is incorrect because returns may be material if they can be reliably estimated.

[344] Gleim #: 3.54 -- Source: CMA 1287 3-26 If receivables transferred with recourse qualify for derecognition, the proceeds from the transfer are

A. B. C. D.

Accounted for as a collateralized borrowing. Recorded at fair value for the assets obtained and liabilities incurred. Recorded at the historical cost of the assets obtained. Reduced by the fair value of the recourse obligation. Answer (A) is incorrect because the proceeds of the sale are reduced by the fair value of the recourse obligation. Answer (B) is incorrect because the proceeds of the sale are reduced by the fair value of the recourse obligation. Answer (C) is incorrect because the proceeds of the sale are reduced by the fair value of the recourse obligation. Answer (D) is correct. The entity derecognizes financial assets if it has transferred substantially all of the risks and rewards of ownership. Derecognition also is appropriate when the entity neither has transferred nor retained substantially all the risks and rewards of ownership, providing the entity does not have control. After derecognition, periodic profit or loss will include the difference between the carrying amount transferred and the proceeds, plus or minus any prior adjustment reflecting the fair value of the asset that had been reported in equity. If a new financial asset is created or a new financial liability is assumed, the calculation is adjusted for the fair value of the asset or liability. Thus, the proceeds of the sale are reduced by the fair value of the recourse obligation (a new financial liability). When the transfer does not meet these criteria, the transfer is accounted for as a collateralized borrowing.

[345] Gleim #: 3.55 -- Source: Publisher A transferor entity most likely should continue to recognize a transferred financial asset if

A. B. C. D.

The transferor may reacquire the asset, and the asset is readily obtainable in the market. The transferee may sell the full fair value of the asset. The transferor has an option to reacquire the asset, and the reacquisition price is fair value. The transferor is entitled and obligated to repurchase the asset, and the transferee receives a lenders return.

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Answer (A) is incorrect because a financial asset should be derecognized despite the transferors right to reacquire it if the asset is readily obtainable in the market. Answer (B) is incorrect because, when the transferee has the ability unilaterally to sell the entire asset to an unrelated third party without transfer restrictions, the transferor lacks control. Answer (C) is incorrect because a financial asset should be derecognized despite the transferors option to reacquire it at fair value at the date of reacquisition. Answer (D) is correct. An entity derecognizes a financial asset if it has transferred substantially all of the risks and rewards of ownership. Derecognition also is appropriate when the entity neither has transferred nor retained substantially all the risks and rewards of ownership, providing the entity does not have control. A transferor does not derecognize the financial asset if it is entitled and obligated to repurchase or redeem the asset, and the terms of this transaction in effect allow the transferee to obtain a lenders return on the assets it receives in exchange for the transferred financial asset. [346] Gleim #: 3.56 -- Source: Publisher Derivatives that are not hedging instruments are always classified in which category of financial instruments?

A. B. C. D.

Financial assets or liabilities held for trading. Held-to-maturity investments. Loans and receivables. Available-for-sale financial assets. Answer (A) is correct. Financial assets or liabilities at fair value through profit or loss include those held for trading. Regardless of intent, a financial asset is held for trading if it is included in a portfolio with a recent pattern of short-term profit taking. Derivatives also are deemed to be held for trading unless they are designated and effective as hedging instruments. Answer (B) is incorrect because held-to-maturity investments have fixed or determinable payments and a fixed maturity. Moreover, the entity must have a positive intent and ability to hold such investments to maturity. Answer (C) is incorrect because loans and receivables are not derivatives. Answer (D) is incorrect because available-for-sale financial assets are nonderivatives. They do not fall within one of the other classifications.

[347] Gleim #: 3.57 -- Source: Publisher Subsequent to their initial recognition, which financial assets with quoted market prices in an active market are measured at fair value?

Held-toMaturity Investments A. B. C. D. Yes Yes No No

Loans and Receivables Yes Yes No No

Availablefor-Sale Financial Assets Yes No Yes No

Financial Assets Held for Trading No No Yes Yes

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Answer (A) is incorrect because available-for-sale and held-for-trading financial assets are measured at fair value unless they do not have quoted market prices in an active market and their fair values cannot be reliably measured. Answer (B) is incorrect because available-for-sale and held-for-trading financial assets are measured at fair value unless they do not have quoted market prices in an active market and their fair values cannot be reliably measured. Answer (C) is correct. Subsequent measurement of financial assets is normally at fair value. Thus, derivative, available-forsale, and held-for-trading financial assets are measured at fair value. Loans and receivables and held-to-maturity investments are measured at amortized cost using the effective interest rate method. Unquoted equity instruments whose fair value is not reliably measurable are reported at cost. Answer (D) is incorrect because available-for-sale and held-for-trading financial assets are measured at fair value unless they do not have quoted market prices in an active market and their fair values cannot be reliably measured. [348] Gleim #: 3.58 -- Source: Publisher Assuming an available-for-sale financial asset that is not part of a hedge is remeasured to fair value at the balance sheet, the gain or loss not arising from foreign exchange transactions or impairment

A. B. C. D.

Must be recognized in profit or loss. Must be recognized directly in equity. May be recognized in profit or loss or directly in equity. Must be recognized in profit or loss if the result is a loss and directly in equity if the result is a gain. Answer (A) is incorrect because a gain or loss on a financial asset or liability classified as at fair value through profit or loss is recognized in profit or loss. Answer (B) is correct. A gain or loss on an available-for-sale financial asset that is not part of a hedge is recognized directly in equity through the statement of changes in equity except for impairment losses and foreign exchange gains and losses. The accumulated remeasurement gain or loss is included in profit or loss when the asset is derecognized. Answer (C) is incorrect because a gain or loss on an available-for-sale financial asset is normally recorded directly in equity. Answer (D) is incorrect because a gain or loss on an available-for-sale financial asset is normally recorded directly in equity.

[349] Gleim #: 3.59 -- Source: CIA 597 IV-15 A retail entity maintains a markup of 25% based on cost. The entity has the following information for the current year: Purchases of merchandise Freight-in on purchases Sales Ending inventory 690,000 25,000 900,000 80,000

Beginning inventory was

A. B. C. D.

40,000 85,000 110,000 265,000

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Answer (A) is incorrect because 40,000 is based on a 25% markup on sales. Answer (B) is correct. Cost of goods sold equals beginning inventory, plus purchases (including freight-in), minus ending inventory. Given that sales reflect 125% of cost, cost of goods sold must equal 720,000 (900,000 sales 1.25). Consequently, the beginning inventory must have been 85,000 (720,000 CGS + 80,000 EI 690,000 purchases 25,000 freight-in). Answer (C) is incorrect because 110,000 omits the freight-in from the computation of cost of goods available for sale. Answer (D) is incorrect because 265,000 uses the sales figure for cost of goods sold. [350] Gleim #: 3.60 -- Source: CIA 597 IV-16 Which inventory pricing method generally approximates current cost for each of the following?

Ending Inventory A. B. C. D. FIFO LIFO FIFO LIFO

Cost of Goods Sold FIFO FIFO LIFO LIFO

Answer (A) is incorrect because LIFO approximates current cost of goods sold. Answer (B) is incorrect because FIFO approximates current cost for ending inventory, and LIFO approximates current cost of goods sold. Answer (C) is correct. FIFO assigns the most recent purchase prices to ending inventory and the earliest purchase prices to cost of goods sold. LIFO uses the earliest acquisition costs to price the ending inventory. It is not permitted by the IFRSs. Thus, FIFO approximates current cost for ending inventory, and LIFO approximates current cost of goods sold. Answer (D) is incorrect because FIFO approximates current cost for ending inventory. [351] Gleim #: 3.61 -- Source: CIA 596 IV-11 The cost of materials has risen steadily over the year. Which of the following methods of estimating the ending balance of the materials inventory account will result in the highest net profit, assuming all other variables remain constant?

A. B. C. D.

Last-in, first-out (LIFO). First-in, first-out (FIFO). Weighted average. Specific identification. Answer (A) is incorrect because LIFO yields the lowest net profit. It is not permitted by the IFRSs. Answer (B) is correct. Net profit will be higher when cost of goods sold is lower, other factors held constant. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. Accordingly, cost of goods sold will be lowest when the ending inventory is highest. Ending inventory is highest under FIFO because the older, less expensive items are deemed to have been sold, leaving the more expensive items in the ending inventory. Answer (C) is incorrect because weighted average averages inventory, so it results in a lower net profit than FIFO. Answer (D) is incorrect because, under specific identification, the newest (most expensive) items are not necessarily in the ending inventory. The result is a higher cost of goods sold and lower net profit than under FIFO.

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[352] Gleim #: 3.62 -- Source: CIA 1193 IV-31 A physical inventory count showed an entity had inventory costing 1,000,000 on hand at December 31, 20X3. Excluded from this amount were the following: Goods costing 82,000, shipped to a customer free on board (FOB) shipping point on December 28, 20X3. They were expected to be received by the customer on January 4, 20X4. Goods costing 122,000, shipped to a customer free on board (FOB) destination December 30, 20X3. They were expected to be received by the customer on January 5, 20X4. Compute the correct ending inventory to be reported on the shippers balance sheet at December 31, 20X3.

A. B. C. D.

1,000,000 1,082,000 1,122,000 1,204,000 Answer (A) is incorrect because 1,000,000 excludes the goods shipped FOB destination. Answer (B) is incorrect because 1,082,000 excludes the goods shipped FOB destination and fails to exclude the goods shipped FOB shipping point. Answer (C) is correct. The goods shipped FOB shipping point should be counted in the buyers, not the sellers, inventory because title and risk of loss pass at the time and place of shipment. These goods were properly excluded from ending inventory. The goods shipped FOB destination were improperly excluded from the sellers ending inventory. The title and risk of loss did not pass until the time and place where the goods reached their destination and were duly tendered. Thus, the correct ending inventory is 1,122,000 (1,000,000 beginning balance + 122,000 goods shipped FOB destination). Answer (D) is incorrect because 1,204,000 includes the goods shipped FOB shipping point.

[353] Gleim #: 3.63 -- Source: CIA 1191 IV-31 When a perpetual inventory system is used and a difference exists between the perpetual inventory amount balance and the physical inventory count, a separate entry is needed to adjust the perpetual inventory amount. Which of the following demonstrates that adjusting entry?

A. Inventory over and short Inventory B. Extraordinary loss due to write-down of inventory Inventory C. Extraordinary loss due to write-down of inventory Allowance for inventory shortages D. Cost of goods sold Retained earnings appropriated for shortages Answer (A) is correct. The entry to record a write-down is a debit to inventory over and short and a credit to inventory. This amount is reported as an adjustment of cost of goods sold or as an other expense on the income statement. Answer (B) is incorrect because a difference between a physical count and a perpetual inventory balance is common. Reasons include normal and expected shrinkage, breakage, shoplifting, and faulty record keeping. Thus, it is not an extraordinary item. Answer (C) is incorrect because a difference between a physical count and a perpetual inventory balance is common. Reasons include normal and expected shrinkage, breakage, shoplifting, and faulty record keeping. Thus, it is not an extraordinary item. Answer (D) is incorrect because, although the debit to cost of goods sold is acceptable, the credit should be to inventory. Also, any appropriation of retained earnings would also have to involve the unappropriated retained earnings account.

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[Fact Pattern #20] Illustrated below is a perpetual inventory card for the current year.

Date January 1 January 12 March 15 May 5 July 8 November 24

Units Purchased

Units Sold

Units Balance 0

1,000 @ 2.00 300 500 @ 2.20 500 1,000 @ 1.65

1,000 700 1,200 700 1,700

Additional Information: The entity had no opening inventory. The items sold on March 15 were purchased on January 12. The items sold on July 8 were purchased on May 5. [354] Gleim #: 3.64 -- Source: CIA 596 IV-17 (Refers to Fact Pattern #20) The ending inventory balance under the first-in, first-out (FIFO) method of inventory valuation is

A. B. C. D.

3,050 3,150 3,230 3,430 Answer (A) is incorrect because 3,050 is the ending inventory under the specific identification method. Answer (B) is correct. Under the FIFO method, the 1,700 units of ending inventory are valued at the most recent prices. Ending inventory is assumed to include 1,000 units purchased November 24, 500 units purchased May 5, and 200 units purchased January 12. Hence, the ending inventory is 3,150 [(1,000 1.65) + (500 2.20) + (200 2.00)]. Answer (C) is incorrect because 3,230 is the ending inventory under the weighted-average method. Answer (D) is incorrect because 3,430 is the ending inventory under the LIFO method.

[355] Gleim #: 3.65 -- Source: CIA 596 IV-18 (Refers to Fact Pattern #20) The cost of goods sold under the specific identification method of inventory valuation is

A. B. C. D.

1,320 1,520 1,600 1,700

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Answer (A) is incorrect because 1,320 is the cost of goods sold under the LIFO method. Answer (B) is incorrect because 1,520 is the cost of goods sold under the weighted-average method. Answer (C) is incorrect because 1,600 is the cost of goods sold under the FIFO method. Answer (D) is correct. Of the 800 units sold during the period, the 300 units sold on March 15 were purchased on January 12 at a cost of 2.00 per unit. The remaining 500 units were purchased on May 5 at a cost of 2.20 per unit. The cost of goods sold under the specific identification method is therefore 1,700 [(300 units 2.00) + (500 units 2.20)]. [356] Gleim #: 3.66 -- Source: CIA 1192 IV-43 An entity had the following selected per-unit data relating to work-in-process: Selling price Completion costs Historical cost Replacement cost Normal gross profit Selling cost 100 10 91 108 20 5

In comparison with historical cost, what will be the per-unit impact on gross profit of measuring ending inventory?

A. B. C. D.

No effect. Reduction of 6. Reduction of 26. Increase of 5. Answer (A) is incorrect because no effect implies that NRV is at least as high as cost. Answer (B) is correct. Inventories are measured at the lower of cost or net realizable value (NRV). NRV equals selling price minus completion and selling costs. Given that historical cost is 91 and NRV is 85 (price of 100 10 completion cost 5 selling cost), the effect on per-unit gross profit is a reduction of 6. This amount is the writedown expensed. Answer (C) is incorrect because a reduction of 26 results from treating normal gross profit as if it were a completion or selling cost. Answer (D) is incorrect because an increase is permissible only to the extent of a prior writedown.

[357] Gleim #: 3.67 -- Source: CIA 1196 IV-22 An entity started in 20X4 with 200 scented candles on hand at a cost of 3.50 each. These candles sell for 7.00 each. The following schedule represents the purchases and sales of candles during 20X4: Transaction Number 1 2 3 4 5 6 7 Quantity Purchased --250 --200 --350 --Unit Cost --3.30 --3.10 --3.00 --Quantity Sold 150 --100 --200 --300

If the entity uses periodic FIFO inventory pricing, the gross profit for 20X4 would be

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A. B. C. D.

2,755 2,805 2,854 2,920 Answer (A) is incorrect because 2,755 equals sales minus purchases. Answer (B) is correct. The FIFO method assumes that the first goods purchased are the first goods sold and that ending inventory consists of the latest purchases. Moreover, whether the inventory system is periodic or perpetual does not affect FIFO valuation. The cost of goods sold is 2,445 {beginning inventory (200 units 3.50) + purchases [(250 units 3.30) + (200 units 3.10) + (350 units 3.00)] ending inventory (250 units 3.00)}. Thus, the gross profit for 20X4 using FIFO is 2,805 [sales (750 units 7.00) cost of goods sold of 2,445]. Answer (C) is incorrect because 2,854 uses a weighted-average ending inventory and part of the cost of goods sold calculation. Answer (D) is incorrect because 2,920 uses a periodic LIFO inventory value.

[358] Gleim #: 3.68 -- Source: CIA 1196 IV-9 The following data are available from the records of a department store for the year ended December 31, 20X3: At cost Merchandise inventory, as of January 1, 20X3 Purchases Markups (net) Markdowns (net) Sales At retail

9,000 33,000

13,000 46,000 1,000 4,000 48,000

Using the retail method to approximate valuation at lower of average cost or net realizable value, the department stores merchandise inventory at December 31, 20X3, is

A. B. C. D.

8,400 8,000 6,000 5,600

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Answer (A) is incorrect because 8,400 neglects to subtract the net markdowns to compute the merchandise inventory at retail at December 31, 20X3. Answer (B) is incorrect because 8,000 is the inventory at retail at December 31, 20X3. Answer (C) is incorrect because 6,000 is computed by including the net markdowns in the cost-to-retail ratio. Answer (D) is correct. The version of the retail method that approximates a lower-of-average-cost-or-NRV valuation includes markups but not markdowns in the cost-to-retail ratio. Thus, the cost of the inventory at December 31, 20X3 is 5,600. Cost Inventory, January 1, 20X3 Purchases Markups, net 9,000 33,000 Retail 13,000 46,000 1,000 60,000 (48,000) (4,000) 8,000 .70 5,600

42,000 Sales Markdowns, net Inventory at retail, December 31, 20X3 Cost-to-retail ratio (42,000 60,000) Inventory at cost, December 31, 20X3

[359] Gleim #: 3.69 -- Source: CIA 595 IV-15 An entity is depreciating an asset with a 5-year useful life. It cost 100,000 and has no residual value. If the <List A> method is used, depreciation in the second year will be <List B>.

List A A. B. C. D. Sum-of-years-digits Sum-of-years-digits 200% diminishing-balance 200% diminishing-balance

List B 20,000 40,000 16,000 24,000

Answer (A) is incorrect because depreciation in year two will be 20,000 under the straight-line method. Answer (B) is incorrect because, under the SYD method, second-year depreciation will be 26,667 [(4 15) 100,000]. Answer (C) is incorrect because 16,000 is based on the 100% diminishing-balance method. Answer (D) is correct. The 200% diminishing-balance method uses twice the straight-line rate. Accordingly, first-year depreciation expense is 40,000 (100,000 20% 2). In the second year, the depreciation base is reduced by the amount of depreciation already taken in the first year. Thus, depreciation expense in year two is 24,000 [(2 20%) (100,000 40,000)]. [360] Gleim #: 3.70 -- Source: CIA 595 IV-10 Which of the following is not an appropriate basis for measuring the cost of property, plant, and equipment?

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A. The purchase price, freight costs, and installation costs of a productive asset should be included in the assets cost. B. Proceeds obtained in the process of readying land for its intended purpose, such as from the sale of cleared timber, should be recognized immediately as income. C. The costs of improvements to equipment incurred after its acquisition should be added to the assets cost if they increase future service potential. D. All costs incurred in the construction of a plant building, from excavation to completion, should be considered as part of the assets cost. Answer (A) is incorrect because the purchase price, freight costs, and installation costs of a productive asset are included in the assets cost. Answer (B) is correct. Accordingly, items of property, plant, and equipment (PPE) that meet the recognition criterion are initially measured at cost. The cost includes the purchase price (minus trade discounts and rebates, plus purchase taxes) and the directly attributable costs of bringing the assets to working condition for their intended use. Directly attributable costs include site preparation, installation, initial delivery and handling, architect and equipment fees, costs of removing the assets and restoring the site, etc. Accordingly, the cost of land includes the cost of obtaining the land and readying it for its intended uses, but it is inappropriate to recognize the proceeds related to site preparation immediately in profit or loss. They should be treated as reductions in the price of the land. Answer (C) is incorrect because subsequent costs are added to the carrying amount of an item of PPE if it is probable that, as a result, future economic benefits will be received, and the costs are reliably measurable. Answer (D) is incorrect because all costs of construction should be included as a part of the assets cost. [361] Gleim #: 3.71 -- Source: CIA 1196 IV-10 A depreciable asset has an estimated 20% residual value. At the end of the assets estimated useful life, the accumulated depreciation will equal the original cost of the asset under which of the following depreciation methods?

DiminishingBalance A. B. C. D. Yes Yes No No

Sum-of-the-Years'Digits (SYD) Yes No Yes No

Answer (A) is incorrect because at the end of the estimated useful life of a depreciable asset, the amount of accumulated depreciation should equal the depreciable cost (original cost estimated residual value), regardless of the depreciation method used. Answer (B) is incorrect because at the end of the estimated useful life of a depreciable asset, the amount of accumulated depreciation should equal the depreciable cost (original cost estimated residual value), regardless of the depreciation method used. Answer (C) is incorrect because at the end of the estimated useful life of a depreciable asset, the amount of accumulated depreciation should equal the depreciable cost (original cost estimated residual value), regardless of the depreciation method used. Answer (D) is correct. At the end of the estimated useful life of a depreciable asset, the amount of accumulated depreciation should equal the depreciable cost (original cost estimated residual value), regardless of the depreciation method used. Periodic diminishing-balance depreciation is calculated without regard to residual value, but the asset is not depreciated below its residual value. The SYD method uses a depreciable base equal to cost minus residual value.

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[362] Gleim #: 3.72 -- Source: CIA 596 IV-22 An entity donated land to a municipality for a park. The acquisition cost of the land was 75,000, and the market value at the time of the donation was 200,000 as determined by a professional appraisal. If the entity has not chosen to adopt the cost model for measurement of property, plant, and equipment subsequent to initial recognition, the journal entry to record the disposition of the land is

A. Expense Land B. Land Revaluation surplus Revaluation surplus Income Expense Land C. Land Revaluation surplus Expense Land D. Donation expense Land Income

75,000 75,000 125,000 125,000 125,000 125,000 200,000 200,000 125,000 125,000 200,000 200,000 200,000 75,000 125,000

Answer (A) is incorrect because the revaluation of the land must be recognized. Answer (B) is incorrect because the revaluation surplus is not transferred through profit or loss. Answer (C) is correct. An item of PPE is carried at cost minus any accumulated depreciation and impairment losses. Under the allowed alternative treatment, an item of PPE may be carried at a revalued amount equal to fair value at the revaluation date minus any subsequent accumulated depreciation and impairment losses. Land is not depreciated, so it should be carried at its revalued amount. This amount should be determined by a professional appraisal. The revaluation increased the carrying amount and is therefore credited directly to equity as revaluation surplus. Accordingly, the entry is to debit land and credit revaluation surplus for 125,000. The entire surplus may be transferred to retained earnings (but not through profit or loss) when the asset is derecognized. Upon derecognition, the asset should be removed from the balance sheet, and the resulting loss (revalued carrying amount of 200,000 0 net disposal proceeds = 200,000) should be included in profit or loss. Answer (D) is incorrect because the revaluation surplus is not transferred through profit or loss. [363] Gleim #: 3.73 -- Source: CIA 1195 IV-22 An entity sells a piece of machinery, for cash, prior to the end of its estimated useful life. The sale price is less than the carrying amount of the asset on the date of sale. The entry that the entity uses to record the sale is

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A. Cash Accumulated depreciation -- machinery Expense-disposal of machinery Machinery B. Cash Accumulated depreciation -- machinery Income-disposal of machinery Machinery C. Cash Expense-disposal of machinery Accumulated depreciation -- machinery Machinery D. Cash Machinery Accumulated depreciation -- machinery Expense-disposal of machinery Answer (A) is correct. The cash account is debited for the amount of the sale proceeds. The machinery account and the related accumulated depreciation account are eliminated by a credit and a debit, respectively. Because the sale price was less than the carrying amount of the asset on the date of sale, a loss on disposal should be recognized in profit or loss. The term expenses includes losses. Answer (B) is incorrect because a loss on disposal should be recognized in profit or loss. The term expenses includes losses. Answer (C) is incorrect because accumulated depreciation should be debited. Answer (D) is incorrect because an expense and accumulated depreciation should be debited. [364] Gleim #: 3.74 -- Source: CIA 1196 IV-29 If an entity employs the sum-of-the-years-digits (SYD) method of depreciation for an asset with an estimated useful life of 4 years, the percentage of the total depreciable cost that will be expensed in the third year is

A. B. C. D.

10% 25% 20% 70% Answer (A) is incorrect because 10% is the amount expensed in the last year. Answer (B) is incorrect because 25% is the percentage expensed each year under the straight-line method. Answer (C) is correct. Under the SYD method, the amount of the depreciable cost that is expensed each year is the remaining useful life at the beginning of that year divided by the sum of the years of useful life. For the third year, the portion expensed is 20% [2 (1 + 2 + 3 + 4)]. Answer (D) is incorrect because 70% is the total amount expensed in the first 2 years.

[365] Gleim #: 3.75 -- Source: CIA 1193 IV-42 In making a cash flow analysis of property, plant, and equipment (PPE), the internal auditor discovered that depreciation expense for the period was 10,000. PPE with a cost of 50,000 and related accumulated depreciation of 30,000 was sold for a gain of 1,000. If the carrying amount of PPE increased by 80,000 during the period, how much PPE was purchased this period?

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A. B. C. D.

91,000 100,000 110,000 119,000 Answer (A) is incorrect because 91,000 ignores the carrying amount of items sold and includes the gain in the computation. Answer (B) is incorrect because 100,000 ignores the depreciation expense for the period. Answer (C) is correct. The carrying amount of the PPE account, net of accumulated depreciation, is increased by the cost of purchases and decreased by the carrying amount of items of PPE sold and depreciation. The net PPE decreased by the carrying amount of items sold, or 20,000 (50,000 cost 30,000 accumulated depreciation), and by the 10,000 of depreciation. If PPE still increased by 80,000, 110,000 (30,000 total decrease + 80,000 increase) of equipment must have been purchased. Answer (D) is incorrect because 119,000 double counts depreciation expense and deducts the gain.

[366] Gleim #: 3.76 -- Source: CIA 1193 IV-38 A theme park purchased a new, exciting ride and financed it through the manufacturer. The following facts pertain: Purchase price Delivery cost Installation cost Cost of trial-runs Interest charges for first year 800,000 50,000 70,000 40,000 60,000

The straight-line method is to be used. Compute the depreciation on the equipment for the first year assuming an estimated service life of 5 years.

A. B. C. D.

160,000 184,000 192,000 204,000 Answer (A) is incorrect because 160,000 excludes the delivery, installation, and trial-run costs. Answer (B) is incorrect because 184,000 excludes the trial-run cost. Answer (C) is correct. Under the straight-line method, the annual depreciation expense for an asset equals the assets amount (cost residual value) divided by the assets estimated useful life. The cost of the asset includes its price and the directly attributable costs of bringing it to working condition for intended use. Thus, the depreciation expense is 192,000 [(800,000 purchase price + 50,000 delivery cost + 70,000 installation cost + 40,000 trial-run cost) 5-year estimated service life]. Borrowing costs incurred after the asset is prepared for its intended use are expensed even if the allowed alternative treatment of such costs is followed, and the asset otherwise satisfies the criteria for capitalization of such expenses. Answer (D) is incorrect because 204,000 includes the borrowing costs.

[367] Gleim #: 3.77 -- Source: CIA 1196 IV-32 On January 1, 20X0, an entity purchased an abandoned quarry for 1,200,000 to be used as a landfill to service its trash collection contracts with nearby cities for the next 20 years. The entity depletes the quarry using the units-of-production method based on a surveyors measurements of volume of the quarrys pit. This amount was 500,000 cubic yards when purchased and 350,000 cubic yards at year-end 20X4. What is the net amount that should be shown on the entitys December 31, 20X4, balance sheet for the quarry?

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A. B. C. D.

1,200,000 900,000 840,000 360,000 Answer (A) is incorrect because 1,200,000 is the purchase price of the quarry. Answer (B) is incorrect because 900,000 results from using straight-line depletion. Answer (C) is correct. The units-of-production method allocates cost based on output. The net amount reported as an asset for the quarry using this method is 840,000 [(350,000 cubic yards 500,000 total cubic yards) 1,200,000]. Answer (D) is incorrect because 360,000 equals {1,200,000 [(350,000 500,000) 1,200,000]}. The 350,000 cubic yards is the volume remaining in the quarrys pit at year-end 20X4, not the volume depleted.

[368] Gleim #: 3.78 -- Source: CIA 592 IV-28 An entity installed an assembly line in 20X0. Four years later, 100,000 was invested to automate the line. The automation increased the market value and productive capacity of the assembly line but did not affect its useful life. Proper accounting for the cost of the automation should be to

A. B. C. D.

Report it as an expense in 20X4. Establish a separate account for the 100,000. Allocate the cost of automation between the asset and accumulated depreciation accounts. Debit the cost to the property, plant, and equipment account. Answer (A) is incorrect because the cost should be capitalized. Answer (B) is incorrect because the same account should be used. Answer (C) is incorrect because allocation is not an accepted procedure. Answer (D) is correct. Subsequent costs are added to the carrying amount of an item of PPE if it is probable that, as a result, future economic benefits will be received, and the costs are reliably measurable. An extended useful life, improved output quantity or quality, and reduced operating costs future economic benefits.

[369] Gleim #: 3.79 -- Source: CIA 1196 IV-18 An entity purchased new equipment on July 1, 20X4, having a list price of 52,500. The entity traded old equipment that was being depreciated using the straight-line method and paid 35,000 in cash. The following information pertains to the old equipment: Cost on January 1, 20X1 Estimated useful life Residual value Fair value on July 1, 20X4 38,900 5 years 2,900 16,000

If the old and new equipment are dissimilar, the entity will record the new equipment at

A. B. C. D.

45,100 48,700 51,000 52,500

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Answer (A) is incorrect because 45,100 equals the carrying amount of the old equipment after being depreciated for 4 years plus the cash paid for the new equipment. Answer (B) is incorrect because 48,700 equals the carrying amount of the old equipment after being depreciated for 3.5 years plus cash paid for the new equipment. Answer (C) is correct. The cost of what is received in an exchange of similar or dissimilar items of PPE is recorded at fair value unless the exchange lacks economic substance or the fair value of what is given or received is not reliably measurable. Hence, the entity will record the new equipment at the fair value of the old asset plus cash paid, or 51,000 (16,000 + 35,000). Answer (D) is incorrect because 52,500 is the list price of the new equipment. [370] Gleim #: 3.80 -- Source: CIA 595 IV-25 Which of the following is not considered to be an intangible asset?

A. B. C. D.

Goods on consignment. Patents. Copyrights. Trademarks. Answer (A) is correct. IAS 38, Intangible Assets, defines an intangible asset as an identifiable nonmonetary asset without physical substance. Inventory is a tangible asset. Thus, goods on consignment are not intangible assets. Answer (B) is incorrect because patents are intangible assets. Answer (C) is incorrect because copyrights are intangible assets. Answer (D) is incorrect because trademarks are intangible assets.

[371] Gleim #: 3.81 -- Source: CIA 593 IV-32 The costs of start-up activities, including fees of attorneys, should be

A. B. C. D.

Capitalized, but not amortized, because of the indefinite life of the business. Capitalized and amortized. Capitalized and deferred until liquidation of the business. Expensed when incurred. Answer (A) is incorrect because start-up costs are expensed when incurred. Answer (B) is incorrect because start-up costs are expensed when incurred. Answer (C) is incorrect because start-up costs are expensed when incurred. Answer (D) is correct. Expenditures on start-up activities are expensed when incurred unless they are included in the cost of an item of property, plant, and equipment. They include the costs of establishing a new legal entity, such as legal and secretarial costs; pre-opening costs of an entitys new business facility; and the pre-operating costs of new operations, products, or processes.

[372] Gleim #: 3.82 -- Source: Publisher A recognized intangible asset is amortized over its useful life

A. B. C. D.

Unless the pattern of consumption of the economic benefits of the asset is not reliably determinable. If that life is determined to be finite. Unless the precise length of that life is not known. If that life is indefinite but not infinite.

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Answer (A) is incorrect because an intangible asset is amortizable if its useful life is finite. If the pattern of consumption of the economic benefits of such an intangible asset is not reliably determinable, the straight-line amortization method is applied. Answer (B) is correct. A recognized intangible asset is amortized over its useful life if that useful life is finite, that is, unless the useful life is determined to be indefinite. The useful life of an intangible asset is indefinite if no foreseeable limit exists on the period over which it will contribute, directly or indirectly, to the reporting entitys cash flows. Answer (C) is incorrect because, if the precise length of the useful life is not known, an intangible asset with a finite useful life is amortized over the best estimate of its useful life. Answer (D) is incorrect because a recognized intangible asset is not amortized if its useful life is indefinite. [373] Gleim #: 3.83 -- Source: CIA 590 IV-25 The amortization of intangible assets with finite useful lives is justified by the

A. B. C. D.

Economic entity assumption. Going concern assumption. Monetary unit assumption. Historical cost assumption. Answer (A) is incorrect because the economic entity assumption is that every entitys affairs are separate from those of its owners. Answer (B) is correct. Every business is assumed to be a going concern that will continue operating indefinitely. Thus, liquidation values are not important. If an entity is not a going concern, its intangible assets are reported at liquidation values, not at historical cost net of amortization. Answer (C) is incorrect because the monetary unit assumption provides that all transactions and events can be measured in terms of money. Answer (D) is incorrect because the historical cost principle deems cost to be the most objective and reliable measure.

[374] Gleim #: 3.84 -- Source: CIA 595 IV-71 The restriction that manufacturers should not market a new product that is illegally similar to that of another companys product is due to which public policy instrument?

A. B. C. D.

Copyright. Minimum standards for product warranties. Anti-merger laws. Patent laws. Answer (A) is incorrect because a copyright provides legal protection for tangible expressions of ideas, e.g., novels, songs, and software. Answer (B) is incorrect because laws establishing minimum warranty standards do not limit the similarity of product offerings. Answer (C) is incorrect because anti-merger laws can affect the ability of one entity to acquire another entity producing similar products if the result will be to lessen competition, but they do not affect the design of new products. Answer (D) is correct. A patent is the exclusive legal right to use or sell an invention, such as a device or process. A patent may be given to any new and useful process, machine, manufacture, or composition of matter, and any infringement of a patent is a basis for a lawsuit. Thus, patent laws require that entities not design new products that are illegally similar to those of other entities that enjoy patent protection.

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[375] Gleim #: 3.85 -- Source: CIA 593 IV-43 MNO purchased all of XYZs 100,000 outstanding common shares for 40 per share on August 31. On this date, XYZs balance sheet showed total assets of 5,000,000 and total liabilities of 2,000,000. The fair value of XYZs identifiable assets on this date was 550,000 greater than their carrying amount. The amount that should be reported on MNOs consolidated balance sheet on August 31 for goodwill is

A. B. C. D.

0 450,000 550,000 1,000,000 Answer (A) is incorrect because cost in excess of fair value of the identifiable assets and liabilities is reported as goodwill. Answer (B) is correct. Goodwill is recognized as an asset equal to the excess of the cost over the acquirers interest in the fair value of the identifiable assets and liabilities acquired. The cost of 4,000,000 (40 100,000) is in excess of the 3,550,000 (5,000,000 + 550,000 2,000,000) fair value of the identifiable assets and liabilities by 450,000. This excess is goodwill. Answer (C) is incorrect because 550,000 is the excess of fair value over the carrying amount of the identifiable assets and liabilities on the sellers books. Answer (D) is incorrect because the purchase price of 4,000,000 exceeds the sellers 3,000,000 carrying amount by 1,000,000.

[376] Gleim #: 3.86 -- Source: Publisher Which of the following is not classified as a development activity?

A. B. C. D.

Evaluation of process alternatives. Construction of a pilot plant. Construction of a preproduction prototype. Design of tools involving new technology. Answer (A) is correct. Evaluation of process alternatives is an activity typically classified as research. Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding (IAS 38). Answer (B) is incorrect because construction of a pilot plant is a development activity. Answer (C) is incorrect because construction of a preproduction prototype is a development activity. Answer (D) is incorrect because the design of tools involving new technology is an activity typically classified as development.

[377] Gleim #: 3.87 -- Source: Publisher On January 1, 20X2, Chertco acquired a patent for 500,000 and using the straight-line method began amortizing it properly over its estimated useful life of 10 years. The asset has no residual value. At December 31, 20X5, a significant change in the business climate caused Chertco to assess the recoverability of the carrying amount of the patent. Chertco estimated that the discounted future net cash inflows from the patent would be 325,000 and that its fair value minus cost to sell was 275,000. Accordingly, for the year ended December 31, 20X5, Chertco should recognize an impairment loss of

A. B. C. D.

175,000 50,000 25,000 0

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Answer (A) is incorrect because 175,000 assumes no amortization. Answer (B) is incorrect because 50,000 is the excess of the estimated discounted future net cash inflows over the fair value minus cost to sell. Answer (C) is incorrect because 25,000 is the excess of the carrying amount over the fair value minus cost to sell. Answer (D) is correct. The entity should determine whether the carrying amount exceeds the recoverable amount. The recoverable amount is the greater of fair value minus cost to sell (275,000) or value in use (the present value of expected cash flows from the asset, or 325,000). Thus, Chertco should recognize no impairment loss because the estimated discounted future net cash inflows (325,000) exceed the carrying amount {500,000 [4 years (500,000 10 years)] = 300,000}. [378] Gleim #: 3.88 -- Source: CIA 593 IV-27 An airline should recognize revenue from airline tickets in the period when

A. B. C. D.

Passenger reservations are booked. Passenger reservations are confirmed. Tickets are issued. Related flights occur. Answer (A) is incorrect because a sufficient degree of certainty that economic benefits will flow to the enterprise does not exist when the reservations are booked or confirmed. Answer (B) is incorrect because a sufficient degree of certainty that economic benefits will flow to the enterprise does not exist when the reservations are booked or confirmed. Answer (C) is incorrect because a sufficient degree of certainty that economic benefits will flow to the enterprise does not exist when the ticket is issued. Answer (D) is correct. Recognition of an element of financial statements (e.g., income, which includes revenue and gains) requires that two criteria be met. It must be probable that any future economic benefit associated with the item will flow to or from the enterprise, and the cost or value of the item must be measurable with reliability. The usual procedures for income recognition, e.g., that income be earned, reflect these criteria. Thus, income is recognized when an increase in future economic benefits is associated with an increase in an asset or a decrease in a liability. The recognition criteria are not met with respect to the collections from sales of airline tickets until the receipt of future economic benefits is sufficiently certain. Such certainty exists when the airline performs the contracted-for service, that is, when the related flights occur. The critical event in the earning process for the airline is the delivery of the service to the customer, which occurs when the related flight takes place.

[379] Gleim #: 3.89 -- Source: CIA 1192 IV-27 A company provides fertilization, insect control, and disease control services for a variety of trees, plants, and shrubs on a contract basis. For 50 per month, the company will visit the subscribers premises and apply appropriate mixtures. If the subscriber has any problems between the regularly scheduled application dates, the companys personnel will promptly make additional service calls to correct the situation. Some subscribers elect to pay for an entire year because the company offers an annual price of 540 if paid in advance. For a subscriber who pays the annual fee in advance, the company should recognize the related revenue

A. B. C. D.

When the cash is collected. Evenly over the year as the services are performed. At the end of the contract year after all of the services have been performed. At the end of the fiscal year.

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Answer (A) is incorrect because a liability is recognized when the cash is collected prior to the rendition of the service. Answer (B) is correct. Income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably. The most common time at which these two conditions are met is when the product or merchandise is delivered or services are rendered to customers. In the situation presented, the performance of the service (monthly spraying) is so significant to creating a sufficient certainty of an increase in future economic benefits that revenue should not be recognized until delivery occurs. Answer (C) is incorrect because revenue from services rendered is recognized when the services have been performed. A portion of the services is performed monthly. Thus, a portion of the related revenue should be recognized monthly rather than waiting until the entire contract year is complete. Answer (D) is incorrect because a portion of the related revenue should be recognized monthly rather than waiting until the entire fiscal year is complete. [Fact Pattern #21] A company had the pre-closing trial balance at December 31 shown. Additional information: The balance of opening inventory was 140,000. The long-term debt pays interest at a rate of 10% per annum, payable every 12 months. The debt was issued on July 1 of the current year and originally had 5 years to maturity. The assets classified as property, plant, and equipment (exclusive of land) have a 10-year estimated useful life and were 1 year old at the start of the current year. Straight-line depreciation is used by the company.

Cash Accounts receivable Inventory Gross property, plant, and equipment Accumulated depreciation Accounts payable Long-term debt Share capital Retained earnings (Jan. 1) Sales revenue Purchases Administrative expenses [380] Gleim #: 3.90 -- Source: CIA 594 IV-2

80,000 100,000 230,000 600,000 60,000 200,000 1,000,000 2,000,000 500,000 750,000 530,000 200,000

(Refers to Fact Pattern #21) On the year-end financial statements, the company will report cost of goods sold of

A. B. C. D.

440,000 620,000 670,000 900,000

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Answer (A) is correct. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. Hence, cost of goods sold is 440,000 (140,000 + 530,000 230,000). Answer (B) is incorrect because 620,000 is obtained by reversing the opening and closing inventory figures. Answer (C) is incorrect because 670,000 omits closing inventory from the calculation. Answer (D) is incorrect because 900,000 adds, rather than subtracting, closing inventory. [381] Gleim #: 3.91 -- Source: CIA 594 IV-3 (Refers to Fact Pattern #21) Which is the correct order of the following four steps in the accounting cycle? Step 1 Step 2 Step 3 Step 4 prepare adjusting journal entries take a post-closing trial balance prepare an adjusted trial balance prepare reversing entries

A. B. C. D.

1, 3, 2, 4 4, 1, 3, 2 3, 1, 2, 4 1, 2, 3, 4 Answer (A) is correct. The accounting cycle may be summarized as consisting of nine steps: record the periods transactions in the appropriate journals, post to the ledger(s) from the journals, prepare an unadjusted trial balance, prepare and post adjusting journal entries, prepare an adjusted trial balance, prepare the financial statements, prepare and post the closing entries, take a post-closing trial balance, and prepare reversing entries (optional). Answer (B) is incorrect because the preparation of reversing entries is the last step in the accounting cycle. Answer (C) is incorrect because the adjusted trial balance is prepared after adjusting entries are made. Answer (D) is incorrect because the post-closing trial balance is prepared after adjusting entries and the adjusted trial balance are completed.

[382] Gleim #: 3.92 -- Source: CIA 591 IV-43 On 1/1/X1, an enterprise acquired a plant asset for 300,000. Using the straight-line method of depreciation over a service life of 10 years with no residual value, the enterprise recorded depreciation of 30,000 for the year ending 12/31/X1. The fair value of the asset at 12/31/X1 is not reliably measurable but is estimated to be 310,000. If the enterprise uses the appropriate treatment for the measurement of property, plant, and equipment subsequent to initial recognition, the balance sheet prepared on 12/31/X1 will

A. B. C. D.

Report the excess of the fair value over the carrying amount as goodwill. Report the excess of the fair value over the carrying amount as part of property, plant, and equipment. Report the excess of the fair value over the carrying amount in equity as revaluation surplus. Not report the excess of the fair value over the carrying amount.

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Answer (A) is incorrect because an excess of fair value over the carrying amount of a plant asset is not reflected in conventional financial statements if the fair value is not reliably measurable. Answer (B) is incorrect because an excess of fair value over the carrying amount of a plant asset is not reflected in conventional financial statements if the fair value is not reliably measurable. Answer (C) is incorrect because an excess of fair value over the carrying amount of a plant asset is not reflected in conventional financial statements if the fair value is not reliably measurable. Answer (D) is correct. An item of property, plant, and equipment may be carried at a revalued amount equal to fair value minus any subsequent accumulated depreciation and impairment losses. An increase in the carrying amount after a revaluation is credited directly to equity as revaluation surplus. However, revaluation is not allowed when the fair value is not reliably measurable. Thus, the measurement of property, plant, and equipment subsequent to initial recognition as an asset is at cost minus any accumulated depreciation and impairment losses. The plant asset should be reported at its carrying amount of 270,000 [300,000 (300,000 10 years)]. [383] Gleim #: 3.93 -- Source: CIA 1192 IV-30 The management of ABC Corporation is analyzing the financial statements of XYZ Corporation because ABC is strongly considering purchasing a block of XYZ ordinary shares that would give ABC significant influence over XYZ. Which financial statement should ABC primarily use to assess the amounts, timing, and certainty of future cash flows of XYZ Company?

A. B. C. D.

Income statement. Statement of changes in equity. Statement of cash flows. Balance sheet. Answer (A) is incorrect because the statement of income is prepared on an accrual basis and is not meant to report cash flows. Answer (B) is incorrect because the statement of changes in equity is prepared on the accrual basis. Answer (C) is correct. A statement of cash flows provides information about the cash receipts and cash payments of an enterprise during a period. This information helps investors, creditors, and other users to assess the enterprises ability to generate cash and cash equivalents and the needs of the enterprise to use those cash flows. Historical cash flow data indicate the amount, timing, and certainty of future cash flows. It is also a means of verifying past cash flow assessments and of determining the relationship between profits and net cash flows and the effects of changing prices. Answer (D) is incorrect because the balance sheet reports on financial position at a moment in time.

[384] Gleim #: 3.94 -- Source: CIA 1191 IV-32 In a statement of cash flows (indirect method), depreciation expense should be presented as

A. B. C. D.

An inflow of cash. An outflow of cash. An addition to net profit in converting net profit or loss to net cash flows from operating activities. A deduction from net profit in converting net profit or loss to net cash flows from operating activities.

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Answer (A) is incorrect because depreciation does not involve an inflow or outflow of cash. The purchase and the sale of property, plant, and equipment constitute investing activities, but the process of depreciating such assets is not defined as an investing activity. Depreciation is a noncash operating expense. Answer (B) is incorrect because depreciation is a noncash operating expense. Answer (C) is correct. Net cash flow from (used by) operating activities may be reported indirectly by removing from net profit or loss the effects of (1) deferrals of past operating cash flows, (2) accruals of expected future operating cash flows, (3) income or expense items related to financing and investing cash flows, and (4) noncash transactions. These adjustments include such items as depreciation, amortization of patents, amortization of bond discount and bond premium, gains and losses, changes during the period in trade receivables, changes in inventory, and changes in accounts payable and accrued liabilities. In the reconciliation of net profit or loss to net cash from (used by) operations, depreciation (a noncash expense) is added to net profit or loss. Answer (D) is incorrect because depreciation should be added. [385] Gleim #: 3.95 -- Source: CIA 592 IV-35 A financial statement includes all of the following items: net profit, depreciation, operating activities, and financing activities. What financial statement is this?

A. B. C. D.

Balance sheet. Income statement. Statement of cash flows. Statement of changes in equity. Answer (A) is incorrect because the balance sheet does not include periodic net profit or loss or depreciation expense. Answer (B) is incorrect because the income statement does not have captions for operating and financing activities. Answer (C) is correct. A statement of cash flows is a required financial statement. It provides information about cash receipts and payments by reporting the cash effects of an enterprises operating, investing, and financing activities. Related disclosures report the effects of noncash investing and financing activities. If the statement is presented using the indirect method, it will reconcile net profit or loss to net cash from (used in) operating activities. Depreciation, a noncash expense, is included in this presentation. Answer (D) is incorrect because the statement of changes in equity does not include captions for operating and investing activities and depreciation.

[386] Gleim #: 3.96 -- Source: CIA 592 IV-36 An enterprise decided to sell a separate major line of its business. The assets were sold for 100,000 and had a net carrying amount of 70,000. The applicable tax rate was 20%. The result of this transaction may appear on the

A. B. C. D.

Balance sheet as a fundamental error. Income statement as an extraordinary item. Income statement as a single amount for a discontinued operation. Income statement as a change in accounting policy.

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Answer (A) is incorrect because a fundamental error is no longer recognized under IFRSs. Answer (B) is incorrect because extraordinary items are not recognized. Answer (C) is correct. A discontinued operation (DO) is a component of an entity that has been disposed of or meets the criteria for classification as held for sale. It is (1) a separate major line of business or geographical operating area, (2) part of a single plan to dispose of such a line or area, or (3) a subsidiary acquired solely for resale. A component of an entity consists of operations and cash flows that are clearly distinguishable from the rest of the entity for financial reporting as well as operationally. A single amount is disclosed on the face of the income statement equal to the sum of (1) after-tax profit (loss) on DOs and (2) after-tax gain (loss) on (a) remeasurement of noncurrent assets (or disposal groups) classified as held for sale at fair value minus cost to sell or (b) disposal of the assets or disposal groups that constituted the DO. Answer (D) is incorrect because accounting policies guide the preparation and presentation of financial statements. [387] Gleim #: 3.97 -- Source: CIA 1191 IV-40 A company uses the percentage-of-completion method and reports the following: Year 1 Construction costs Estimated cost to complete at year-end 100 300 Year 2 200 0

The contract price is 1,000. What is the gross profit recognized in year 2?

A. B. C. D.

150 400 550 800 Answer (A) is incorrect because gross profit recognized in year 2 is 550. Answer (B) is incorrect because gross profit recognized in year 2 is 550. Answer (C) is correct. At the end of year 1, total cost was expected to be 400 (100 incurred + 300 estimated cost to complete), and estimated total gross profit was 600 (1,000 price 400 estimated total cost). Hence, the amount of gross profit recognized in year 1 was 150 [600 (100 cost incurred 400 estimated total cost)]. The project was completed in year 2 at an additional cost of 200. Actual gross profit was therefore 700 (1,000 300 actual total cost). Gross profit recognized in year 2 is 550 (700 total 150 recognized in year 1). Answer (D) is incorrect because gross profit recognized in year 2 is 550.

[388] Gleim #: 3.98 -- Source: CIA 594 IV-30 Which of the following is not an appropriate basis for measuring the historical cost of property, plant, and equipment?

A. Delivery and handling costs and installation costs of a productive asset should be included in the assets cost. B. The cost should include the purchase price without a deduction for trade discounts. C. The costs of improvements to equipment incurred after its acquisition should be added to the assets cost if they provide future economic benefits exceeding the originally assessed standard of performance. D. All costs incurred in the construction of a plant building, from excavation to completion, should be considered as part of the assets cost.

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Answer (A) is incorrect because directly attributable costs of bringing the asset to working condition for its intended use are included in its cost. Answer (B) is correct. An asset classified under property, plant, and equipment is measured initially at cost. This amount includes the purchase price and any directly attributable costs of bringing the asset to working condition for its intended use. Directly attributable costs include costs of, for example, site preparation, initial delivery and handling, installation, professional fees (e.g., those of architects and engineers), and dismantling and removing the asset and restoring the site. The purchase price is determined by adding any import fees and nonrefundable purchase taxes and subtracting any trade discounts and rebates. Answer (C) is incorrect because subsequent expenditures should be added to the carrying amount if it is probable that they will result in future economic benefits exceeding the originally assessed standard of performance. Answer (D) is incorrect because the costs of a self-constructed asset are determined in the same way as those of an acquired asset. Hence, all costs of construction of a building are included in its initially recorded cost because they are directly attributable costs of bringing the asset to its working condition for its intended use. [389] Gleim #: 3.99 -- Source: CIA 590 IV-31 DEF is the consignee for 1,000 units of product X for ABC Company. ABC should recognize the revenue from these 1,000 units when

A. B. C. D.

The agreement between DEF and ABC is signed. ABC ships the goods to DEF. DEF receives the goods from ABC. DEF sells the goods and informs ABC of the sale. Answer (A) is incorrect because the revenue recognition criteria for sales of goods are not met in a consignment until the consignee sells the goods to a third party. Answer (B) is incorrect because the revenue recognition criteria for sales of goods are not met in a consignment until the consignee sells the goods to a third party. Answer (C) is incorrect because the revenue recognition criteria for sales of goods are not met in a consignment until the consignee sells the goods to a third party. Answer (D) is correct. Under a consignment arrangement, the consignor ships merchandise to the consignee who acts as agent for the consignor in selling the goods. The goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignors inventory. Revenue and the related cost of goods sold from these consigned goods should only be recognized by the consignor when the merchandise is sold and delivered to the final customer. Accordingly, recognition occurs when notification is received that the consignee has sold the goods. Only then are the recognition criteria for a sale of goods satisfied: the enterprise has transferred the significant risks and rewards of ownership, the enterprise has neither continuing managerial involvement to an extent associated with ownership nor effective control over the goods, the amount can be reliably measured, it is probable that the economic benefits will flow to the enterprise, and transactional costs can be reliably measured.

[390] Gleim #: 3.100 -- Source: CIA 1193 IV-37 ABC Manufacturing Company ships merchandise costing 40,000 on consignment to XYZ Stores. ABC pays 3,000 of freight costs to a transport company, and XYZ pays 2,000 for local advertising costs that are reimbursable from ABC. By the end of the period, three fourths of the consigned merchandise has been sold for 50,000 cash. XYZ notifies ABC of the sales, retains a 10% commission and the paid advertising costs, and remits the cash due ABC. Select the journal entry that appropriately records the notification of sale and the receipt of cash by ABC.

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A. Cash Advertising expense Commission expense Freight expense Revenue from consignment sales B. Cash Advertising expense Commission expense Revenue from consignment sales C. Cash Revenue from consignment sales D. Cash Commission expense Revenue from consignment sales

40,000 2,000 5,000 3,000 50,000 43,000 2,000 5,000 50,000 50,000 50,000 45,000 5,000 50,000

Answer (A) is incorrect because the freight was paid earlier in the period and would have been recorded then by a credit to cash and a debit to inventory. Thus, the freight costs will be included in the determination of net profit when cost of goods sold is recognized. Answer (B) is correct. ABC debits the cash received 43,000 [50,000 sales 2,000 advertising (.10 50,000) sales commission]. The advertising and commission expenses are debited for 2,000 and 5,000, respectively. Finally, 50,000 of gross revenue is credited. Answer (C) is incorrect because the 10% commission and the advertising costs are ignored in this answer. Answer (D) is incorrect because the reimbursable advertising costs are ignored in this answer. [391] Gleim #: 3.101 -- Source: CIA 592 IV-34 On December 1, year 1, a company using the installment sales method sold goods that cost 1,000 for 1,500. The buyer paid 100 down. Monthly payments start January 1, year 2. Interest accrues at 1% per month on the unpaid balance. To the nearest dollar, the effect on profit for year 1 is

A. B. C. D.

33 increase. 47 increase. 67 increase. 114 increase. Answer (A) is incorrect because 33 is the net profit effect excluding interest revenue of 14 [.01 (1,500 100)]. Answer (B) is correct. The gross profit margin is 33 1/3% [(1,500 1,000) 1,500], so the amount of profit from the 100 down payment recognizable in year 1 is 33 (rounded). Interest accrued on the 1,400 (1,500 100) balance for 1 month is 14. Consequently, the effect on profit is 47 (33 + 14). Answer (C) is incorrect because 67 is the cost of goods sold [(1,000 1,500) 100]. Answer (D) is incorrect because 114 {100 + [.01 (1,500 100)]} is the total revenue, not the profit.

[392] Gleim #: 3.102 -- Source: CIA 1189 IV-9 On January 31, 20X3, a company prepaid the 72,000 rental fee for a parking lot it leases. The rental fee covered a 3-year period beginning February 1, 20X3. What is the effect of this transaction on the December 31, 20X3 financial statements for each of the following?

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Current Expenses A. B. C. D. 0 22,000 24,000 72,000

Prepaid Expenses 72,000 50,000 48,000 0

Answer (A) is incorrect because the expenses relating to the current year need to be recognized. Answer (B) is correct. The 72,000 rental fee should be recognized as expense evenly over the 36-month duration of the lease. In 20X3, 22,000 should be debited to current expenses (11 months 72,000 36), and 50,000 should be deferred as prepaid expense. Answer (C) is incorrect because 24,000 is the expense recognized for 12 months instead of the 11 months from January 31, 20X3 to December 31, 20X3. Answer (D) is incorrect because only those expenditures related to the current year should be expensed. [393] Gleim #: 3.103 -- Source: CIA 1189 IV-29 A department store sells gift certificates that may be redeemed for merchandise. Each certificate expires 3 years after issuance. The revenue from the gift certificates should be recognized

A. B. C. D.

Evenly over 3 years from the date of issuance. In the period the certificates are sold. In the period the certificates expire. In the period the certificates are redeemed or in the period they expire if they are allowed to lapse. Answer (A) is incorrect because there is no basis for such an allocation. Answer (B) is incorrect because, when the certificates are sold, future economic benefits are neither sufficiently certain nor reliably measurable. The store has not yet performed its obligations created by the sales of gift certificates. Answer (C) is incorrect because revenue is also recognized when certificates are redeemed. Answer (D) is correct. Income, which includes revenue and gains, should not be recognized until an increase in future economic benefits related to an increase in an asset or a decrease in a liability is sufficiently certain and can be measured reliably. These criteria are met when the certificates are redeemed or expire because the liability for redemptions will then decrease and economic benefits will be reliably measurable.

[394] Gleim #: 3.104 -- Source: CIA 1185 IV-20 Which of the following costs is most likely to be expensed immediately rather than recognized as an asset?

A. B. C. D.

Development. Equipment. Goodwill. Research.

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Answer (A) is incorrect because an internally generated intangible asset may arise from the development (but not the research) phase of asset generation. An asset is recognized if the enterprise demonstrates the technical feasibility of completing the asset, the intent to complete and use or sell the asset, the ability to use or sell it, how it will generate probable future economic benefits, the availability of resources to complete development and to use or sell the asset, and the ability to make a reliable measurement of development expenditures for the asset. Answer (B) is incorrect because items of equipment that qualify for asset recognition are initially measured at cost. The depreciable amounts of these assets are then allocated as expense (unless included in the carrying amount of other assets) over their useful lives. Answer (C) is incorrect because goodwill arising from a business combination that meets the definition of an acquisition is recognized as an asset. It is not amortized. However, impairment of goodwill is recognized as a loss. Answer (D) is correct. Research expenditures should be expensed when incurred. No intangible asset resulting from research should be recognized. The enterprise cannot demonstrate at this stage that future economic benefits are probable. [Fact Pattern #22] On January 1, 20X3, a construction company signed a contract with a property management firm involving the construction of a large urban office tower. The total price of constructing the tower was agreed to be 10 million with 2 million being paid on the date of the agreement. Construction began immediately upon the signing of the contract and was expected to take 3 years to complete. The original estimate of total construction costs was 8 million. During the year ended December 31, 20X3, 4 million of construction costs were incurred, and engineering estimates indicated that the office tower was 30% complete at year-end. At year-end, the revised estimate of total construction costs was 8.5 million and the property management firm had been billed a further 4 million, although only 1 million of that amount had been collected by year-end. [395] Gleim #: 3.105 -- Source: CIA 1194 IV-8 (Refers to Fact Pattern #22) If the construction company uses the percentage-of-completion (cost-to-cost basis) method of revenue recognition, in 20X3 the amount of revenue it will recognize on the long-term contract will be

A. B. C. D.

3,000,000 4,705,882 5,000,000 6,000,000 Answer (A) is incorrect because 3,000,000 is based on the engineering estimate of the stage of completion. Answer (B) is correct. Under the cost-to-cost approach to determining the stage of completion of the contract, the stage of completion equals contract costs incurred to date divided by the most recent estimate of total contract costs. Hence, the revenue to be recognized in the first year is 4,705,882 [(4,000,000 8,500,000) 10,000,000]. This amount equals costs incurred plus recognized profit. Answer (C) is incorrect because 5,000,000 is based on the original estimate of contract costs. Answer (D) is incorrect because 6,000,000 is based on the percentage of total revenue billed to date.

[396] Gleim #: 3.106 -- Source: CIA 1194 IV-9 (Refers to Fact Pattern #22) Assume that the construction company recognizes 2 million of revenue for the long-term contract in 20X3. If the company uses the percentage-of-completion method (cost-to-cost basis), the difference between revenue recognized to date and contract billings at the end of 20X3 will be shown on the December 31, 20X3 balance sheet as a <List A> of <List B>.

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List A A. B. C. D. Current asset Current asset Current liability Current liability

List B 1,000,000 4,000,000 1,000,000 4,000,000

Answer (A) is incorrect because an excess of billings over the sum of costs and recognized profits is a liability, and 1,000,000 is the amount of cash collected. Answer (B) is incorrect because an excess of billings over the sum of costs and recognized profits is a liability. Answer (C) is incorrect because 1,000,000 equals cash collected. Answer (D) is correct. The gross amount due from (to) customers for contract work is an asset (liability). If the amount of costs incurred plus recognized profits minus recognized losses exceeds progress billings, the enterprise presents an asset. If the amount of progress billings exceeds costs incurred plus recognized profits minus recognized losses, the enterprise presents a liability. At the end of 20X3, the company had recognized 2,000,000 of revenue (costs to date + recognized profit) and had submitted billings of 6,000,000. Thus, the excess billings equal 4,000,000. Because the billings exceed revenue recognized, this amount is listed as a current liability. It represents unearned revenue. NOTE: Given a 10 million fixed price and 8.5 million of total costs, the assumption that 2 million of revenue was recognized under the percentage-of-completion method (cost-to-cost basis) necessarily includes the assumption that the stage of completion was 20% (2 million 10 million), that recognized profit was 300,000 [20% (10 million 8.5 million)], and that costs to date were 1.7 million (20% 8.5 million). [Fact Pattern #23] On January 1, a new landscaping firm acquired a fleet of vehicles, all the necessary tools and equipment, and a parking and storage facility. It began operations immediately. It is now the end of the first year of operations, and the first set of year-end financial statements are being prepared. Several decisions have to be made regarding the appropriate accounting and reporting practices for this company. Relevant information for several of these items is described in the following list of transactions and events: At year-end, the parking and storage facility that was purchased for 150,000 has a fair value of 250,000. The physical flow of inventory is first in, first out, and the cost of materials has risen steadily over the year. To promote sales for the coming year, maintenance contracts were sold in December at very reasonable prices, provided that the customers paid cash. On April 1, the company arranged a 100,000, 10% bank loan. Interest payments of 5,000 are due on October 1 and April 1 of each year during the 5-year term of the loan. During the first year of operations, the company experienced a 5% bad debt rate on credit sales. None of the bad debts are expected to be recovered, given that 5% is the industry average level of bad debts. Total credit sales for the year were 400,000. The year-end balance of accounts receivable, which includes uncollected overdue accounts, is 100,000. Half of the uncollected overdue amounts are estimated to be uncollectible. [397] Gleim #: 3.107 -- Source: CIA 1194 IV-25 (Refers to Fact Pattern #23) The company will recognize revenue from the December sale of the maintenance contracts in the <List A> year if it selects <List B> basis reporting.

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List A A. B. C. D. First First Second Third

List B Cash Accrual Cash Accrual

Answer (A) is correct. Under the cash basis of accounting, revenue is recognized when the cash is received. Because the customers paid cash for the maintenance contracts in the first year, that is the year in which the revenue should be recognized. Answer (B) is incorrect because, if the accrual basis is used, revenue received for the maintenance contracts is recognized after the first year. The services are provided and the revenue recognition criteria are met after year one. Answer (C) is incorrect because, under cash-basis accounting, the revenue received in the first year is recognized in the first year. Answer (D) is incorrect because accrual-basis accounting recognizes the revenue in year two. Services will be provided in year two. [398] Gleim #: 3.108 -- Source: CIA 1194 IV-26 (Refers to Fact Pattern #23) The company will report a value of <List A> for the parking and storage facility if it prepares financial reports consistent with the <List B> principle.

List A A. B. C. D. 150,000 150,000 250,000 250,000

List B Matching Historical cost Going concern Revenue recognition

Answer (A) is incorrect because the matching principle requires the recognition of related revenues and expenses in the same accounting period. Answer (B) is correct. An asset classified under property, plant, and equipment is measured initially at cost. This amount includes the purchase price and any directly attributable costs of bringing the asset to working condition for its intended use. Directly attributable costs include costs of, for example, site preparation, initial delivery and handling, installation, professional fees (e.g., those of architects and engineers), and dismantling and removing the asset and restoring the site. The purchase price is determined by adding any import fees and nonrefundable purchase taxes and subtracting any trade discounts and rebates. Answer (C) is incorrect because the going-concern assumption is that the enterprise will continue in existence indefinitely. Answer (D) is incorrect because revenue recognition principles refer to the timing of revenue recognition, not to the valuation basis for property, plant, and equipment. [399] Gleim #: 3.109 -- Source: CIA 1194 IV-27 (Refers to Fact Pattern #23) If the company uses the <List A> approach to estimate bad debt expense, the estimated bad debt expense will be <List B>.

List A A. B. C. D. Balance sheet Balance sheet Income statement Income statement

List B 20,000 100,000 20,000 50,000

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Answer (A) is incorrect because the balance sheet approach estimates bad debts as a portion of overdue accounts estimated to be uncollectible. Under this approach, the amount estimated to be uncollectible is 50,000 (100,000 50%). Answer (B) is incorrect because the balance sheet approach estimates bad debts as a portion of overdue accounts estimated to be uncollectible. Under this approach, the amount estimated to be uncollectible is 50,000 (100,000 50%). Answer (C) is correct. Using the income statement approach, the bad debt expense is determined using a percentage of total credit sales. Thus, bad debt expense is 20,000 (400,000 credit sales 5% estimated bad debt rate). Answer (D) is incorrect because 50,000 is the estimated bad debt expense using the balance sheet approach. [400] Gleim #: 3.110 -- Source: CIA 1194 IV-28 (Refers to Fact Pattern #23) If the company reports expenses on an accrual basis, interest expense for the first year of operations is

A. B. C. D.

5,000 7,500 10,000 12,500 Answer (A) is incorrect because 5,000 is the interest expense under the cash basis. Answer (B) is correct. The interest expense for the first year equals the 5,000 payment made on October 1 plus the three months accrued interest at year-end, or 7,500 (5,000 + 2,500). Answer (C) is incorrect because 10,000 is the interest expense for a full year. Answer (D) is incorrect because 12,500 is equal to 15 months of interest.

[401] Gleim #: 3.111 -- Source: CIA 595 IV-1 To calculate net sales, <List A> must be <List B> cash receipts from customers.

List A A. B. C. D. An increase in accounts receivable An increase in accounts receivable An increase in accounts payable An increase in accounts payable

List B Added to Subtracted from Added to Subtracted from

Answer (A) is correct. To convert from the cash basis (cash receipts) to the accrual basis (net sales), the increase in net accounts receivable must be added to cash receipts from customers. Answer (B) is incorrect because a decrease in receivables would be subtracted from cash receipts. Answer (C) is incorrect because changes in accounts payable are not included in the calculation of net sales. Answer (D) is incorrect because changes in accounts payable are not included in the calculation of net sales. [402] Gleim #: 3.112 -- Source: CIA 595 IV-3 Which of the following steps in the accounting cycle is completed later than the others?

A. B. C. D.

Adjustments. Journalization. Posting. Identification and measurement of transactions.

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Answer (A) is correct. The order of the steps in the accounting cycle is identification and measurement of transactions and other events required to be recognized, journalization, posting from the journals to the ledgers, the development of a trial balance, adjustments to produce an adjusted trial balance, statement presentation, closing, taking a post-closing trial balance (optional), and making reversing entries (optional). Answer (B) is incorrect because, of the steps listed, journalization occurs second. Answer (C) is incorrect because, of the steps listed, posting occurs third. Answer (D) is incorrect because the identification and measurement of transactions is the first step in the accounting cycle. [403] Gleim #: 3.113 -- Source: CIA 595 IV-4 A company purchased 50,000 worth of office supplies on January 1st and had 15,000 of office supplies still on hand at yearend. If the initial purchase of supplies entry on January 1st was to debit office supplies expense and to credit cash for 50,000, the adjusting entry on December 31 will be

A. Office supplies Office supplies expense B. Office supplies expense Office supplies C. Office supplies Office supplies expense D. Office supplies expense Office supplies

15,000 15,000 15,000 15,000 35,000 35,000 35,000 35,000

Answer (A) is correct. Because the initial entry recorded the entire purchase to a nominal account, the year-end adjusting entry must debit a prepaid asset to reflect the remaining supplies on hand of 15,000. The adjusting entry must also credit (reduce) expenses for the 15,000 of supplies that were not used during the period. Answer (B) is incorrect because the reversing entry is to debit expense and credit a prepaid asset. Answer (C) is incorrect because the appropriate amount is 15,000, not 35,000. Answer (D) is incorrect because the closing entry would have been to debit expense and credit a prepaid asset if the initial entry had been to a real account. [404] Gleim #: 3.114 -- Source: CIA 1196 IV-11 A company began work on a long-term construction contract in year 1. The contract price was 3,000,000. Year-end information related to the contract is as follows: Year 1 Estimated total cost Cost incurred Billings Collections 2,000,000 700,000 800,000 600,000 Year 2 2,000,000 900,000 1,200,000 1,200,000 Year 3 2,000,000 400,000 1,000,000 1,200,000

If the company uses the percentage-of-completion method of accounting for this contract, the gross profit to be recognized in year 1 is

A. B. C. D.

(100,000) 100,000 200,000 350,000

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Answer (A) is incorrect because (100,000) is the difference between costs incurred and collections. Answer (B) is incorrect because 100,000 is the difference between billings and costs incurred. Answer (C) is incorrect because 200,000 is the difference between billings and collections. Answer (D) is correct. When the outcome of a contract can be reasonably estimated, the percentage-of-completion method recognizes revenue based on the stage of completion of the contract. One typical method for estimating the stage of completion is the calculation of ratio of the contract costs incurred to date to the estimated total costs. The percentage-ofcompletion at year-end on the cost-to-cost basis is 35% (700,000 2,000,000). The gross profit for year 1 is the anticipated gross profit on the contract times the completion percentage. Thus, gross profit for year 1 is 350,000 [(3,000,000 2,000,000) 35%]. [405] Gleim #: 3.115 -- Source: CIA 1196 IV-30 A vendor sells specialty inks on consignment to a manufacturer of colored paper at a price of 200 per barrel. Payment is made to the vendor in the month the manufacturer uses the barrels in production. The vendor records revenues when the barrels are shipped and makes no adjusting entries to record unearned revenues until the December 31st closing of the books. At the end of July, the manufacturer had 40 barrels of ink on consignment. During August, the vendor consigned 50 barrels and received payment for 30 barrels. Another 5 barrels were returned to the vendor by the manufacturer for credit. At the end of August, what is the amount of unearned revenue contained in the vendors accounts receivable from the manufacturer?

A. B. C. D.

3,000 4,000 11,000 12,000 Answer (A) is incorrect because 3,000 does not include the 40 barrels consigned in July. Answer (B) is incorrect because 4,000 does not include the 40 barrels consigned in July or deduct the 5 barrels returned. Answer (C) is correct. Under a consignment arrangement, the consignor ships merchandise to the consignee who acts as agent for the consignor in selling the goods. The goods are in the physical possession of the consignee but remain the property of the consignor and are included in the consignors inventory. Revenue and the related cost of goods sold from these consigned goods should only be recognized by the consignor when the merchandise is sold and delivered to the final customer. Accordingly, recognition occurs when notification is received that the consignee has sold the goods. Only then are the recognition criteria for a sale of goods satisfied: the enterprise has transferred the significant risks and rewards of ownership, the enterprise has neither continuing managerial involvement to an extent associated with ownership nor effective control over the goods, the amount can be reliably measured, it is probable that the economic benefits will flow to the enterprise, and transactional costs can be reliably measured. In this consignment arrangement, 30 barrels have been paid for, so the revenue is recognized for these barrels. The 5 barrels returned are not included in unearned revenue because they constitute a return of consigned goods. Accordingly, the amount of inappropriately recognized revenue is 11,000 [(40 consigned + 50 consigned - 30 paid for - 5 returns) x 200]. Answer (D) is incorrect because 12,000 does not reflect the 5 barrels returned.

[406] Gleim #: 3.116 -- Source: CIA 591 IV-52 A project is expected to result in the following adjustments over the next year: Cash sales increase by 400,000. Expenses (except depreciation) increase by 180,000. Depreciation increases by 80,000. Assume the corporate tax rate is 34%. The total relevant net cash flows during that year are

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A. B. C. D.

92,400 140,000 172,400 220,000 Answer (A) is incorrect because 92,400 equals the increase in after-tax net profit. Answer (B) is incorrect because 140,000 is the increase in pre-tax net profit. Answer (C) is correct. The increase in pre-tax net profit is 140,000 (400,000 cash sales increase 180,000 nondepreciation expenses increase 80,000 depreciation). Thus, taxes will increase by 47,600 (34% 140,000), and the increase in net cash inflows will be 172,400 (400,000 180,000 47,600). Answer (D) is incorrect because 220,000 equals cash sales minus expenses other than depreciation.

[407] Gleim #: 3.117 -- Source: CIA 590 IV-55 A company had 30 million in total sales last year and expects 40 million in total sales this year. Ten percent of each years sales are on credit that will be paid the following year. The company anticipates the following expenses for this year: Depreciation of 5 million. Labor, materials, taxes, and other expenses of 51 million. Assume the company begins this year with a zero cash balance. At the end of this year, the company will have a cash deficit of

A. B. C. D.

8 million. 12 million. 15 million. 17 million. Answer (A) is incorrect because 8 million includes next years payments on this years sales in the estimation of this years cash inflows. Answer (B) is correct. The cash inflows from last years credit sales are estimated to be 3,000,000 (10% 30,000,000). The cash inflows from this years sales are expected to be 36,000,000 (90% 40,000,000), a total cash inflow of 39,000,000 for the current year. Ignoring depreciation, which is a noncash expense, cash outflows are estimated at 51,000,000. Hence, the net cash outflow is anticipated to be 12,000,000 (39,000,000 51,000,000). Answer (C) is incorrect because 15 million excludes the 3 million cash inflow that resulted from last years credit sales. Answer (D) is incorrect because 17 million includes depreciation when estimating cash outflows.

[408] Gleim #: 3.118 -- Source: CIA 597 IV-32 The management discussion and analysis section of a companys annual report typically contains

A. B. C. D.

A description of the companys primary business and segments. A discussion of the companys operating results. A discussion of the future prospects of the company. All of the answers are correct.

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Answer (A) is incorrect because a description of the companys primary business and segments, a discussion of the companys operating results, and a discussion of the future prospects of the company are included. Answer (B) is incorrect because a description of the companys primary business and segments, a discussion of the companys operating results, and a discussion of the future prospects of the company are included. Answer (C) is incorrect because a description of the companys primary business and segments, a discussion of the companys operating results, and a discussion of the future prospects of the company are included. Answer (D) is correct. The MD&A section addresses capital resources, liquidity, and operating results. Management must also identify trends and discuss significant events and uncertainties. Thus, the MD&A section typically includes a description of the companys primary business and segments. It reviews the operating results of the company, providing a breakdown of net sales and income by segment. It also contains prospective information on economic trends and market changes, and their potential effects on the companys future performance. [409] Gleim #: 3.119 -- Source: CIA R98 IV-36 The present value of 100,000 due at the end of eight years, at 10%, is 46,650. What is the approximate value of 100,000 invested for the same length of time and at the same rate?

A. B. C. D.

46,650 100,000 114,360 214,360 Answer (A) is incorrect because 46,650 is the present value of 100,000 discounted at 10% for 8 years. Answer (B) is incorrect because 100,000 is the present value of 214,360 discounted at 10% for 8 years. Answer (C) is incorrect because 114,360 is the interest earned. Answer (D) is correct. The present value of a future amount equals that amount divided by the interest factor for the given discount period and discount rate. The interest factor for the present value of 1 due in 8 years and discounted at 10% is 2.1436 (100,000 46,650). Thus, the future value of 100,000 must be 214,360 (2.1436 100,000).

[410] Gleim #: 3.120 -- Source: CIA R98 IV-41 A company purchased a new machine on an installment payment plan and is to make equal annual payments beginning one year from the date of purchase. Using an interest rate of 10%, the cost of the machine can be determined by multiplying one payment by the

A. B. C. D.

Future value of one currency unit. Future value of an annuity due of one currency unit. Present value of one currency unit. Present value of an ordinary annuity of one currency unit. Answer (A) is incorrect because the cost at the date of purchase is the present value of an ordinary annuity. Answer (B) is incorrect because the cost at the date of purchase is the present value of an ordinary annuity. Answer (C) is incorrect because the cost at the date of purchase is the present value of an ordinary annuity. Answer (D) is correct. The cost of the machine is the present value of the annuity (the series of equal periodic payments). The annuity is an ordinary annuity because the payments begin one period after the date of purchase. The cost therefore equals the periodic payment times the interest factor for an ordinary annuity of one currency unit for a specified number of equal periodic payments discounted at a given interest rate.

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[411] Gleim #: 3.121 -- Source: Publisher IAS 34, Interim Financial Reporting, provides guidelines for interim reporting stating that enterprises

A. May use estimates based on sales margins for interim inventory valuation although a different method is used for annual reporting. B. Must determine income tax expense by applying progressive tax rates to income on a quarterly basis. C. May prorate extraordinary items over four quarters. D. Need not disclose basic and diluted earnings per share each quarter. Answer (A) is correct. Essentially the same reporting methods should be used for interim and annual financial statements. However, the preparation of interim financial reports ordinarily requires a greater use of estimates. For example, IAS 34 states that complete inventory-taking and valuation may not be required at interim dates. Estimates based on sales margins may suffice. Answer (B) is incorrect because income tax expense is based on the estimated annual effective income tax rate. Answer (C) is incorrect because the same accounting policies should be applied in the interim statements as in the annual statements. Accordingly, an extraordinary item is to be reported in the interim period in which the gain or loss occurred. Answer (D) is incorrect because the same accounting policies should be applied in the interim statements as in the annual statements. Thus, BEPS and DEPS must be reported. [412] Gleim #: 3.122 -- Source: CIA 1193 IV-30 An enterprise that sprays chemicals in residences to eliminate or prevent infestation of insects requires that customers prepay for 3 months service at the beginning of each new quarter. Select the term that appropriately describes this situation from the viewpoint of the enterprise.

A. B. C. D.

Unearned income. Earned income. Accrued income. Prepaid expense. Answer (A) is correct. The prepayment does not meet the income recognition criteria because the future inflow of economic benefits is not sufficiently certain given that the enterprise has not done what is required to be entitled to those benefits. Thus, the amount received in advance is considered a liability (unearned income) because it represents an obligation to perform a service in the future arising from a past transaction. Answer (B) is incorrect because the income is not earned. The exterminator has not performed the related services for the customer. Answer (C) is incorrect because accrued income has met the recognition criteria but has not been received. Answer (D) is incorrect because the customer has a prepaid expense (expense paid but not incurred).

[413] Gleim #: 3.123 -- Source: CIA 1196 IV-4 The purpose of an entry that contains a debit to prepaid property taxes and a credit to property tax expense is to recognize a(n)

A. B. C. D.

Prepaid expense. Accrued expense. Prepaid income. Expired cost.

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Answer (A) is correct. An entry debiting prepaid property taxes and crediting property tax expense is needed at the balance sheet date when prepayments are initially recorded in an expense account. This adjusting entry defers expense recognition to the future period in which the property taxes apply. Answer (B) is incorrect because the entry records an asset. Answer (C) is incorrect because the entry records an asset. Answer (D) is incorrect because the entry records an unexpired cost (an asset). [414] Gleim #: 3.124 -- Source: CIA 597 IV-3 What are the effects of an adjusting entry used to accrue revenue from credit sales?

Assets A. B. C. D. Decrease Increase No effect No effect

Liabilities No effect No effect Decrease Increase

Equity Decrease Increase Increase Decrease

Answer (A) is incorrect because the accrual of revenue increases assets, increases equity, and has no effect on liabilities. Answer (B) is correct. The journal entry to accrue revenue requires a debit to a receivable account and a credit to a revenue account. Thus, the accrual of revenue increases assets and equity. Answer (C) is incorrect because the accrual of revenue increases assets, increases equity, and has no effect on liabilities. Answer (D) is incorrect because the accrual of revenue increases assets, increases equity, and has no effect on liabilities. [415] Gleim #: 3.125 -- Source: CIA 597 IV-14 A manufacturer receives an advance payment for special-order goods that are to be manufactured and delivered within the next year. The advance payment should be reported in the manufacturers current-year balance sheet as a(n)

A. B. C. D.

Current liability. Noncurrent liability. Contra asset amount. Accrued revenue. Answer (A) is correct. Recognition of an element of financial statements (e.g., income, which includes revenue and gains) requires that two criteria be met. It must be probable that any future economic benefit associated with the item will flow to or from the enterprise, and the cost or value of the item must be measurable with reliability. The usual procedures for income recognition, e.g., that income be earned, reflect these criteria. Thus, income is recognized when an increase in future economic benefits is associated with an increase in an asset or a decrease in a liability. However, the enterprise has not substantially completed what it must do to be entitled to the benefits represented by the advance payment, and the receipt of future economic benefits is not sufficiently certain to merit income recognition. Accordingly, a liability should be recognized because the entity has a current obligation arising from a past event that will require an outflow of economic benefits, that is, to deliver goods or to refund the customers money. The delivery of goods is to take place within a year of the balance-sheet date; therefore, the obligation is expected to be settled in the normal course of the operating cycle or is due to be settled within 12 months. Answer (B) is incorrect because the obligation is current. Answer (C) is incorrect because a contra account reduces the valuation of the related account. Answer (D) is incorrect because the payment has not met the income recognition criteria.

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[416] Gleim #: 3.126 -- Source: CIA 597 IV-28 An enterprise that owns a new professional basketball team sells season tickets to its teams games. The season lasts from November through April, with 10 games played each month. In 20X3, the enterprise collected 3 million from season-ticket sales for the 20X3-20X4 season. Its fiscal year-end is December 31. Based on this information, the enterprise should

A. B. C. D.

Report a liability for unearned income of 2 million on its December 31, 20X3 balance sheet. Report a liability for unearned income of 3 million on its December 31, 20X3 balance sheet. Report income of 3 million on its 20X3 income statement. Report income of 1 million on its 20X4 income statement. Answer (A) is correct. The collections represent a liability (unearned income). The income recognition criteria are not met with respect to the season ticket collections until the receipt of future economic benefits is sufficiently certain. Such certainty exists with respect to collections related to the games played as of the balance sheet date. Accordingly, the enterprise should recognize 1 million as income in 20X3 [2 months (3,000,000 6 months)]. The remaining 2 million should be reported as a liability. Answer (B) is incorrect because the liability at the end of 20X3 is 2 million. Answer (C) is incorrect because the enterprise should report income of 1 million in 20X3 and 2 million in 20X4. Answer (D) is incorrect because the enterprise should report income of 1 million in 20X3 and 2 million in 20X4.

[Fact Pattern #24] An enterprise had the pre-closing trial balance at December 31 shown below. Additional information: The balance of opening inventory was 140,000. The long-term debt pays interest at a rate of 10% per annum, payable every 12 months. The debt was issued on July 1 of the current year and originally had 5 years to maturity. The assets classified as property, plant, and equipment have a 10-year estimated useful life and were 1 year old at the start of the current year. Straight-line depreciation is used.

Cash Accounts receivable Inventory Gross property, plant, and equipment Accumulated depreciation Accounts payable Long-term debt Share capital Retained earnings (Jan. 1) Sales revenue Purchases Administrative expenses [417] Gleim #: 3.127 -- Source: CIA 594 IV-1

80,000 100,000 230,000 600,000 60,000 200,000 1,000,000 2,000,000 500,000 750,000 530,000 200,000

(Refers to Fact Pattern #24) The enterprise uses straight-line depreciation for financial reporting purposes, but uses accelerated depreciation for tax purposes. Which of the following account balances would be lower in the financial statements used for tax purposes than it would be in the general purpose financial statements?

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A. B. C. D.

Accumulated depreciation. Cash. Retained earnings. Gross property, plant, and equipment. Answer (A) is incorrect because the balance of accumulated depreciation is higher in the tax-basis financial statements. Answer (B) is incorrect because depreciation expense is a noncash charge. The cash balance is unaffected by the depreciation method used. Answer (C) is correct. Because the tax basis uses an accelerated method, depreciation expense and accumulated depreciation will be greater. Moreover, taxable income will be lower than financial net income. Consequently, tax-basis retained earnings will be less than that in the general purpose financial statements. Answer (D) is incorrect because the historical cost of property, plant, and equipment is recorded in the gross property, plant, and equipment account. This amount is unaffected by depreciation.

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[Fact Pattern #25] An entitys financial statements for the current year are presented below:

Balance Sheet Cash Accounts receivable Inventory Net fixed assets Total Accounts payable Long-term debt Share capital Retained earnings Total 100 200 50 600 950 140 300 260 250 950

Statement of Income and Retained Earnings Sales Cost of goods sold Gross profit Operations expenses Operating profit Interest expense Profit before tax Income tax Net profit Plus Jan. 1 retained earnings Minus dividends Dec. 31 retained earnings 3,000 1,600 1,400 970 430 30 400 200 200 150 100 250

[418] Gleim #: 3.128 -- Source: CIA 594 IV-5 (Refers to Fact Pattern #25) The enterprise will report year-end total assets of

A. B. C. D.

800,000 890,000 950,000 1,010,000

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Answer (A) is incorrect because 800,000 uses the beginning balance of inventory. Answer (B) is correct. The year-end total assets can be determined by summing all of the assets and deducting accumulated depreciation (including the current years depreciation). Total accumulated depreciation at the end of the second year is 120,000 [(600,000 10 years) 2 years]. Total assets equal 890,000 (80,000 cash + 100,000 A/R + 230,000 EI + 600,000 gross property, plant, and equipment 120,000 accumulated depreciation). Answer (C) is incorrect because 950,000 omits second-year depreciation from the calculation. Answer (D) is incorrect because 1,010,000 omits total accumulated depreciation from the calculation. [419] Gleim #: 3.129 -- Source: CIA 594 IV-4 (Refers to Fact Pattern #24) Which adjusting entry should be used at year-end to account for interest expense on the long-term debt?

A. Interest expense Interest payable B. Interest expense Cash C. Interest payable Interest expense D. Interest expense Interest payable

100,000 100,000 50,000 50,000 100,000 100,000 50,000 50,000

Answer (A) is incorrect because the debt has been outstanding for only 6 months, so accrued interest is only 50,000. Answer (B) is incorrect because the debt pays annual interest on July 1, and no cash outlay is required at year-end. Answer (C) is incorrect because accrued interest is 50,000. Also, interest expense is debited and interest payable is credited. Answer (D) is correct. The debt was issued on July 1 and has been outstanding for only 6 months. Interest expense equals the face amount of the debt multiplied by the interest rate and the fraction of the year the debt was outstanding [1,000,000 10% (6 12) = 50,000]. Because interest is payable on July 1, 6 months interest is accrued and expensed in the current period. The payable is also recognized in the current period. Thus, the adjusting entry should be

Interest expense Interest payable

50,000 50,000

[420] Gleim #: 3.130 -- Source: CIA 594 IV-6 (Refers to Fact Pattern #24) Assume that the enterprise reports cost of goods sold of 200,000 and interest expense of 10,000 for the current period. Also assume a 50% tax rate on corporate earnings. The final closing entry required to ensure that current earnings are incorporated into year-end retained earnings is

A. Income summary Retained earnings B. Retained earnings Income summary C. Income summary Retained earnings D. Retained earnings Income summary

140,000 140,000 280,000 280,000 240,000 240,000 240,000 240,000

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Answer (A) is correct. Current period pretax net income equals 280,000 (750,000 sales 200,000 CGS 60,000 depreciation 10,000 interest 200,000 administrative expenses). Thus, after-tax net income credited to retained earnings equals 140,000 [(1.0 .5) 280,000]. Answer (B) is incorrect because income taxes are omitted and the journal entry is reversed. Answer (C) is incorrect because administrative expenses were omitted. Answer (D) is incorrect because administrative expenses were omitted and the journal entry is reversed. [421] Gleim #: 3.131 -- Source: IIA, adapted The practice of recording advanced payments from customers as liabilities is an application of the

A. B. C. D.

Going concern assumption. Monetary unit assumption. Historic cost principle. Revenue recognition principle. Answer (A) is incorrect because the going concern assumption is that the business will have a long life. This does not relate directly to the practice of recording unearned revenues as liabilities. Answer (B) is incorrect because the monetary unit assumption is that money is the common denominator by which economic activity is conducted, and that the monetary unit provides an appropriate basis for accounting measurement and analysis. It does not relate directly to the practice of recording unearned revenues as liabilities. Answer (C) is incorrect because the historic cost principle is the requirement that most assets and liabilities be accounted for and reported on the basis of acquisition price. It does not relate directly to the practice of recording unearned revenues as liabilities. Answer (D) is correct. Since the amount received in cash has not yet been earned, it is appropriate to record the advance payment as a liability of the company. This is an example of the revenue recognition principle, which states that revenue should not be recognized until it is earned.

[422] Gleim #: 3.132 -- Source: IIA, adapted Which of the following is a product cost for a manufacturing company?

A. B. C. D.

Insurance on the corporate headquarters building. Property taxes on a factory. Depreciation on a salespersons vehicle. The salary of a sales manager. Answer (A) is incorrect because insurance on the corporate headquarters building is not a cost of production and is therefore a period cost. Answer (B) is correct. Product costs such as material, labor, and overhead attach to the product and are carried in future periods if the revenue from the product is recognized in subsequent periods. Period costs are expensed immediately because no direct relationship between cost and revenue exists. Answer (C) is incorrect because depreciation on salespersons vehicles is not a cost of production and is therefore a period cost. Answer (D) is incorrect because the salary of a sales manager is not a cost of production and is therefore a period cost.

[423] Gleim #: 3.133 -- Source: CIA 597 IV-55 An entity has excess capacity in production-related property, plant, and equipment. If in a given year these assets are being used to only 80% of capacity and the sales level in that year is 2 million, the full capacity sales level is

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A. B. C. D.

1,600,000 2,000,000 2,500,000 10,000,000 Answer (A) is incorrect because 1,600,000 is 80% of the actual sales. Answer (B) is incorrect because 2,000,000 equals the actual sales. Answer (C) is correct. Full capacity sales equals actual sales divided by the percentage of capacity at which PPEs were operated. Thus, full capacity sales equals 2,500,000 (2,000,000 80%). Answer (D) is incorrect because 10,000,000 equals actual sales divided by the proportion of unused capacity.

[424] Gleim #: 3.134 -- Source: CIA 1191 IV-14 Actual and projected sales of an entity for September and October are as follows: Cash Sales September (actual) October (projected) 20,000 30,000 Credit Sales 50,000 55,000

All credit sales are collected in the month following the month in which the sale is made. The September 30 cash balance is 23,000. Cash disbursements in October are projected to be 94,000. To maintain a minimum cash balance of 15,000 on October 31, the entity will need to borrow

A. B. C. D.

0 6,000 11,000 16,000 Answer (A) is incorrect because the entity will need to borrow 6,000. Answer (B) is correct. This entity will collect 80,000 (50,000 from September credit sales + 30,000 from October cash sales) in October. To reach its targeted cash balance on October 31, it will have to borrow 6,000.

September 30 cash balance Collections Disbursements Ending balance Necessary borrowing Targeted ending balance

23,000 80,000 (94,000) (14,000) 9,000 6,000 15,000

Answer (C) is incorrect because the entity will need to borrow 6,000. Answer (D) is incorrect because the entity will need to borrow 6,000.

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[425] Gleim #: 3.135 -- Source: CIA 597 IV-34 An entity purchased a machine on January 1, 20X1 for 1,000,000. The machine had an estimated useful life of 9 years and a residual value of 100,000. The company uses straight-line depreciation. On December 31, 20X3, the machine was sold for 535,000. The gain or loss that should be recorded on the disposal of this machine is

A. B. C. D.

35,000 gain. 65,000 loss. 365,000 loss. 465,000 loss. Answer (A) is incorrect because 35,000 gain equals selling price, minus carrying amount, plus residual value. Answer (B) is correct. The accumulated depreciation was 400,000 {[(1,000,000 100,000) 9 years] 4 years}, so the carrying amount was 600,000 (1,000,000 400,000). Thus, the loss was 65,000 (600,000 535,000 sales price). Answer (C) is incorrect because 365,000 loss equals cost, minus selling price, minus residual value. Answer (D) is incorrect because 465,000 loss equals cost minus selling price.

[426] Gleim #: 3.136 -- Source: CIA 597 IV-33 An entity purchased a machine for 700,000. The machine was depreciated using the straight-line method and had a residual value of 40,000. The machine was sold on December 31, 20X1. The accumulated depreciation related to the machine was 495,000 on that date. The entity reported a gain on the sale of the machine of 75,000 in its income statement for the fiscal year ending December 31, 20X1. The selling price of the machine was

A. B. C. D.

280,000 240,000 205,000 115,000 Answer (A) is correct. The selling price minus the carrying amount of the machine equals the gain or loss. The carrying amount equals cost minus accumulated depreciation, or 205,000 (700,000 495,000). Thus, the selling price was 280,000 (205,000 + 75,000 gain). Answer (B) is incorrect because 240,000 equals carrying amount, plus gain, minus residual value. Answer (C) is incorrect because 205,000 is the carrying amount. Answer (D) is incorrect because 115,000 equals the gain plus the residual value.

[427] Gleim #: 3.137 -- Source: CIA R98 IV-39 A transfer of receivables, with recourse, in exchange for cash should

A. B. C. D.

Not be recorded until all of the receivables have been collected. Be recorded as a sale or a borrowing transaction, depending on the provisions of the transfer agreement. Be recorded as a sale of receivables. Be recorded as a borrowing transaction.

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Answer (A) is incorrect because the transferor must recognize cash and either a sale or a borrowing. Answer (B) is correct. An entity derecognizes a financial asset (or a part thereof) when it loses control of the contractual rights the asset represents. Control is lost when the entity realizes the rights to the benefits of the contract, the rights expire, or the entity surrenders the rights. Moreover, whether loss of control has occurred depends on the positions of both the transferor and the transferee. Control is not lost, for example, if the entity may reacquire the asset (unless it is readily obtainable in the market or the price is fair value) or when the transferor is entitled and obligated to repurchase or redeem at a price giving the transferee a lenders return. Control ordinarily is lost when the transferee may obtain the benefits of the asset, for example, if the transferee may freely sell or pledge the full fair value of the asset. When the conditions above are met, the transfer of receivables with recourse is accounted for as a sale, with the proceeds of the sale reduced by the fair value of the recourse obligation (a new financial liability). Answer (C) is incorrect because certain conditions must be met before a sale may be recognized. Answer (D) is incorrect because a sale may be recognized if certain conditions are met. [428] Gleim #: 3.138 -- Source: CIA 1190 IV-46 On January 1, year 1, an entity recorded the purchase of an asset correctly at 275,132. A down payment of 200,000 was made with the balance of 100,000 due in 3 years at an imputed annual interest rate of 10%. What is the year 1 interest to record on the payable?

A. B. C. D.

7,513 8,289 10,000 27,513 Answer (A) is correct. The balance outstanding during the year was 75,132 (275,132 200,000). At an interest rate of 10%, the entity should accrue 7,513.20 (10% 75,132) of interest for the year. Answer (B) is incorrect because 8,289 is the balance due in 3 years minus the balance outstanding during the year divided by 3 [(100,000 75,132) 3]. Answer (C) is incorrect because 10,000 equals 10% of the face amount due. Answer (D) is incorrect because 27,513 equals the interest rate times the cost of the asset (275,132 10%).

[429] Gleim #: 3.139 -- Source: CIA 589 IV-35 The following facts are presented for an entity that uses the retail inventory method: Cost Beginning inventory Purchases Sales Ending inventory (per physical count) at retail prices 28,000 126,000 Retail 40,000 180,000 170,000 45,000

What is the forgone sales revenue from inventory shrinkage?

A. B. C. D.

3,500 5,000 35,000 45,000

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Answer (A) is incorrect because 3,500 is the inventory shrinkage at cost. Answer (B) is correct. The retail inventory method converts ending inventory at retail to cost by applying a cost-retail ratio. The advantage is that a physical inventory can be taken at retail without the necessity of counting individual items at cost. Because this method requires detailed inventory records to be kept at retail, lost sales revenue (at retail) caused by inventory shrinkage can be calculated using the following retail data:

Beginning inventory Purchases Goods available for sale Sales Estimated ending inventory Actual ending inventory Inventory shrinkage

40,000 180,000 220,000 (170,000) 50,000 (45,000) 5,000

Answer (C) is incorrect because 35,000 equals the estimated ending inventory at cost. Answer (D) is incorrect because 45,000 equals the actual ending inventory at retail. [430] Gleim #: 3.140 -- Source: CIA 592 IV-30 An entity purchased 1,000 gross amount of inventory on account with terms of 2% discount if paid within 10 days. The seller was responsible for delivery to the shipping point, with freight of 30 prepaid by the seller. The entity records purchases at the net amount. The journal entry to record payment 8 days after the invoice date is

A. Accounts payable Cash B. Accounts payable Freight-in Cash C. Purchases Freight-in Accounts payable D. Purchases Freight-in Accounts payable

1,010 1,010 980 30 1,010 1,000 30 1,030 980 30 1,010

Answer (A) is correct. Under the net method, the payable is initially credited at the discounted amount. Because the payment was within the discount period and freight was prepaid, the buyers remittance to the seller includes the freight cost of 30 and the discounted price of the merchandise [1,000 (1.0 .02) = 980], a total of 1,010. Answer (B) is incorrect because freight-in was debited at the invoice date (debit freight-in and purchases, credit accounts payable). Accounts payable needs to be debited for the entire amount (including freight of 30) owed to the seller. Answer (C) is incorrect because this entry would have been made at the invoice date if the gross method had been used. Answer (D) is incorrect because this entry was made at the invoice date. [Fact Pattern #26] An entity with a December 31 year-end purchased 2,000 of inventory on account. The seller was responsible for delivery to the shipping point, with freight of 50 paid at destination by the buyer. The invoice date was December 27, 20X1, and the goods arrived on January 3, 20X2.

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[431] Gleim #: 3.141 -- Source: CIA 592 IV-33 (Refers to Fact Pattern #26) Now assume the terms required the seller to deliver to the destination instead of the shipping point. What is the correct amount of inventory and freight-in relating to this purchase on the 20X3 financial statements?

Inventory A. B. C. D. 0 2,050 0 2,000

Freight-In 0 0 50 50

Answer (A) is correct. Title and risk of loss passed to the buyer at the destination, and the seller incurred the expense of delivery to that point. The goods did not arrive until after year-end, so they should not be included in 20X1 inventory. Freight-in should also not be recorded until 20X2. Answer (B) is incorrect because no inventory should be included in the 20X1 financial statements. Answer (C) is incorrect because freight-in should be recorded in 20X2. Answer (D) is incorrect because no inventory should be included in the 20X1 financial statements, and freight-in should be recorded in 20X2. [432] Gleim #: 3.142 -- Source: CIA 594 IV-18 A merchandising company had the following inventory related transactions in its first year of operations: Purchases in Units 10,000 @ 5 6,000 @ 6 3,000 8,000 @ 6.25 12,000 5,000 @ 7 2,000 Sales in Units Balance in Units 10,000 16,000 13,000 21,000 9,000 14,000 12,000

Date Jan. 1 March 1 May 1 July 1 Sept. 1 Nov. 1 Dec. 1

If the company uses the first-in-first-out (FIFO) method of inventory valuation, its ending inventory balance (rounded) will be

A. B. C. D.

62,000 70,759 78,750 84,000 Answer (A) is incorrect because 62,000 is the ending inventory balance under LIFO. Answer (B) is incorrect because 70,759 is the ending inventory balance under the weighted average method. Answer (C) is correct. The first-in-first-out (FIFO) method assumes that the oldest units are used first and the newest units remain in inventory. Because the company has 12,000 units remaining, ending inventory equals 78,750 [(5,000 7) + (7,000 6.25)]. Answer (D) is incorrect because 84,000 computes all 12,000 units of ending inventory at the most recent purchase price of 7.

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[433] Gleim #: 3.143 -- Source: CIA 597 IV-13 An entity has appropriately used the installment method of accounting since it began operations at the beginning of the current year. The following information pertains to its operations for this year: Installment sales Cost of installment sales Collections on installment sales General and administrative expenses 1,200,000 840,000 480,000 120,000

The amount of gross profit deferred at the end of the current year should be

A. B. C. D.

720,000 288,000 216,000 144,000 Answer (A) is incorrect because 720,000 is the year-end balance of installment accounts receivable. Answer (B) is incorrect because 288,000 applies the gross profit percentage to the sum of cost of sales and general and administrative expenses. Answer (C) is correct. The gross profit on installment sales is 360,000 (1,200,000 installment sales 840,000 cost of installment sales). Accordingly, the gross profit percentage is 30% (360,000 gross profit 1,200,000 installment sales), and the amount of gross profit deferred at the end of the current year is 216,000 [30% (1,200,000 installment sales 480,000 collections)]. General and administrative expenses have no effect on the computation of realized gross profit or deferred gross profit. They are to be classified as operating expenses on the income statement in the period in which they are incurred. Answer (D) is incorrect because 144,000 treats general and administrative expenses as costs of installment sales.

[434] Gleim #: 3.144 -- Source: CIA 594 IV-17 The cost of materials has risen steadily over the year. The entity uses its newest materials first when removing items from inventory. Which of the following methods of estimating the ending balance of the materials inventory account will result in the highest net profit, all other variables held constant?

A. B. C. D.

Last-in-first-out (LIFO). First-in-first-out (FIFO). Weighted average. Specific identification. Answer (A) is incorrect because the last-in-first-out (LIFO) method assumes that the most recent and costliest units have been removed from inventory. If costs rise steadily during the accounting period, this method will result in the lowest inventory balance, the highest cost of goods sold, and the lowest net profit. LIFO is not permitted. Answer (B) is correct. The first-in-first-out (FIFO) method assumes that the oldest and hence least costly units are used first, and the newest and most costly items remain in inventory. This method will result in the highest inventory balance if costs rise steadily during the accounting period. Accordingly, FIFO results in the lowest cost of goods sold and the highest net profit. Answer (C) is incorrect because the weighted-average cost method averages the costs of all inventory items and results in a lower inventory balance and net profit than does the FIFO method. Answer (D) is incorrect because specific identification charges the actual cost of each unit to cost of goods sold each period, leaving as inventory the actual cost of all items still in inventory. Given that the newest and most costly items are removed from inventory first, the inventory balance and net profit will be lower than that obtained using FIFO estimation.

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[435] Gleim #: 3.145 -- Source: CIA 593 IV-35 An entity uses the retail method of inventory estimation for interim reporting purposes. Management expects some normal shrinkage in the inventory because of theft. What effect will the failure to consider this shrinkage have on the computation of (1) the cost-retail ratio, and (2) the estimated ending inventory at retail?

(1) Effect on CostRetail Ratio A. B. C. D. No effect No effect Overstatement Overstatement

(2) Effect on Estimated Ending Inventory at Retail No effect Overstatement Overstatement Understatement

Answer (A) is incorrect because shrinkage has no effect on the ratio but should be deducted in arriving at the estimated ending inventory at retail. Answer (B) is correct. The retail method of inventory estimation applies a cost-retail ratio to the ending inventory at retail to determine ending inventory at cost. The ratio equals goods available at cost divided by goods available at retail. Normal inventory shrinkage is deducted from the retail amount of goods available because the goods are not available. However, abnormal amounts of theft, etc., are deducted in arriving at both the cost and retail amounts. The reason for the difference in treatment is that normal but not abnormal inventory losses are anticipated and included in selling price (retail value). Accordingly, failure to account for normal inventory shrinkage has no effect on the calculation of the cost-retail ratio but overstates ending inventory at retail. Answer (C) is incorrect because shrinkage has no effect on the ratio but should be deducted in arriving at the estimated ending inventory at retail. Answer (D) is incorrect because shrinkage has no effect on the ratio but should be deducted in arriving at the estimated ending inventory at retail. [436] Gleim #: 3.146 -- Source: CIA 1193 IV-29 An entity purchases office equipment for 525,000 on account. Select the appropriate journal entry to record this transaction.

A. Office expense Accounts payable B. Office equipment Accounts payable C. Accounts payable Office expense D. Accounts payable Office equipment

525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000

Answer (A) is incorrect because the charge should be to an asset account rather than an expense account. Answer (B) is correct. The purchase of office equipment represents the acquisition of an asset. An increase in an asset is recorded by a debit. The purchase on account increases liabilities. An increase in a liability is recorded by a credit. Answer (C) is incorrect because an increase in accounts payable is recorded by a credit. The purchase of equipment results in an asset that is recorded by a debit to an asset account. Answer (D) is incorrect because an increase in a liability is recorded by a credit. An increase in an asset is recorded by a debit.

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[437] Gleim #: 3.147 -- Source: CIA 592 IV-27 An entity acquired an item of property, plant, and equipment with an estimated useful life of 5 years for 15,000 at the beginning of year 1. For financial statement purposes, how would the depreciation expense calculated using the 200% diminishing-balance method compare with that calculated using the sum-of-the-years-digits method in year 1 and year 2, respectively?

Year 1 A. B. C. D. Lower Lower Higher Higher

Year 2 Lower Higher Lower Higher

Answer (A) is incorrect because 200% diminishing-balance depreciation is higher in year 1. Answer (B) is incorrect because 200% diminishing-balance depreciation is higher in year 1 and lower in year 2. Answer (C) is correct. 200% diminishing-balance is an accelerated depreciation method that determines periodic depreciation expense by multiplying the carrying amount at the beginning of each period by a constant rate that is equal to twice the straight-line rate of depreciation. Each year the carrying amount of the asset decreases by the depreciation expense recognized. Residual value is ignored in determining the carrying amount except as a floor beneath which the asset may not be depreciated. SYD depreciation multiplies a constant depreciable amount (cost - residual value) by the SYD fraction. The SYD fractions numerator is the number of years of remaining useful life (n). The formula to compute the denominator in the SYD method is (n(n+1)) 2. For a 5-year estimated useful life, the denominator of the fraction is 15 [5(5 + 1) 2].

200% DB: SYD:

Year 1 Year 2 Year 1 Year 2

= = = =

15,000(.4) = 6,000 9,000(.4) = 3,600 15,000(5 15) = 5,000 15,000(4 15) = 4,000

Answer (D) is incorrect because 200% diminishing-balance depreciation is lower in year 2. [438] Gleim #: 3.148 -- Source: CIA 1196 IV-36 Which of the following is a noncash item?

A. B. C. D.

Administrative expense. Interest expense. Income tax expense. Depreciation expense. Answer (A) is incorrect because administrative expense is a cash charge. Answer (B) is incorrect because interest expense is a cash charge. Answer (C) is incorrect because income tax expense is a cash charge. Answer (D) is correct. Depreciation expense is a noncash charge. It represents the allocation of the historical cost of assets to the time periods in which they are used to generate revenues.

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[439] Gleim #: 3.149 -- Source: CIA 590 IV-45 An entity purchased the following for 120,000: Sellers Carrying Amount Land Building 50,000 100,000 Estimated Fair Value 60,000 90,000

The land should be recorded at

A. B. C. D.

40,000 48,000 50,000 60,000 Answer (A) is incorrect because 40,000 assumes the purchase price allocation is based on carrying amounts instead of fair values. Answer (B) is correct. An item of PPE is initially measured at its cost. Accordingly, the cost, which equals the 120,000 purchase price, should be allocated between the land and the building based on their respective fair values. The cost of the land should be recorded at 48,000 {120,000 [60,000 (60,000 + 90,000)]}. Answer (C) is incorrect because 50,000 is the sellers carrying amount of the land. Answer (D) is incorrect because 60,000 is the estimated fair value of the land.

[440] Gleim #: 3.150 -- Source: Publisher Whenever an entity must use net realizable value rather than cost to value an inventory item, the inventory account is reduced and the account expense due to decline of inventory to net realizable value is increased. The balance of this account is reflected as a separate item on the

A. B. C. D.

Balance sheet as a deduction from inventory. Income statement as an extraordinary loss. Income statement as a deduction from gross profit on sales. Income statement as an operating expense. Answer (A) is incorrect because the write-down is expensed in the period in which the writedown occurs. Answer (B) is incorrect because the loss is ordinary. Answer (C) is correct. If a separate expense account is not used, the ending inventory will be reduced directly and the result will be an increase in cost of goods sold. No separate disclosure of the inventory writedown will appear in the income statement. The effect is to hide the loss in cost of goods sold. If the separate expense account is used, it appears on the income statement as a deduction from gross profit (sales cost of goods sold). One advantage is that cost of goods sold is not misstated. Answer (D) is incorrect because the writedown is not treated as a selling or administrative expense.

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[441] Gleim #: 3.151 -- Source: CMA 1292 2-5 Aston Company acquired a new machine at a cost of 200,000 and incurred costs of 2,000 to have the machine shipped to its factory. Aston also paid 4,500 to construct and prepare a site for the new machine and 3,500 to install the necessary electrical connections. Aston estimates that the useful life of this new machine will be 5 years and that it will have a residual value of 15,000 at the end of that period. Assuming that Aston acquired the machine on January 1 and will take a full years depreciation, the proper amount of depreciation expense to be recorded by Aston if it uses the 200% diminishing-balance method is

A. B. C. D.

74,000 84,000 80,000 80,800 Answer (A) is incorrect because 74,000 assumes that the depreciable amount is the invoice price minus residual value. Answer (B) is correct. Items of property, plant, and equipment (PPE) that meet the recognition criteria are initially measured at cost. The cost includes the purchase price (minus trade discounts and rebates, plus purchase taxes) and the directly attributable costs of bringing the assets to working condition for their intended use. Hence, the depreciable amount is 210,000 (200,000 invoice price + 2,000 delivery expense + 4,500 site preparation + 3,500 electrical work). Under the 200% DB method, residual value is ignored at the beginning. Thus, the full 210,000 will be subject to depreciation. Given a 5-year life, the annual straight-line rate is 20%, and the 200% DB rate will be 40%. Depreciation for the first year is therefore 84,000 (40% 210,000). Answer (C) is incorrect because the depreciable amount of the machine was 210,000, not the 200,000 invoice price. Answer (D) is incorrect because 80,800 assumes a depreciable amount of 202,000, but the site preparation and electrical costs are part of that cost.

[442] Gleim #: 3.152 -- Source: CMA 683 1-13 An entity often factors its accounts receivable. The finance company requires an 8% reserve and charges a 1.5% commission on the amount of the receivable. The remaining amount to be advanced is further reduced by an annual interest charge of 16%. What proceeds (rounded to the nearest dollar) will the entity receive from the finance company at the time a 110,000 account that is due in 60 days is turned over to the finance company?

A. B. C. D.

81,950 83,630 96,895 99,550 Answer (A) is incorrect because the proceeds would be determined by reducing the 110,000 by 9.5% (8% reserve + 1.5% commission) and then reducing that amount by the interest expense [16% (60 360)]. Answer (B) is incorrect because the proceeds would be determined by reducing the 110,000 by 9.5% (8% reserve + 1.5% commission) and then reducing that amount by the interest expense [16% (60 360)]. Answer (C) is correct. The factor will hold out 8,800 (8% 110,000) as a reserve against returns and allowances and 1,650 (1.5% 110,000) as a commission. That leaves 99,550 to be advanced to the seller. However, interest at the rate of 16% annually is also to be withheld. For 60 days that interest would amount to approximately 2,655 (assuming a 360-day year). The proceeds to be given to the seller equal 96,895 (99,550 2,655). Answer (D) is incorrect because the proceeds would be determined by reducing the 110,000 by 9.5% (8% reserve + 1.5% commission) and then reducing that amount by the interest expense [16% (60 360)].

[443] Gleim #: 3.153 -- Source: Publisher Under IAS 2, Inventories, all of the following should be disclosed when reporting inventories except

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A. B. C. D.

The use of the lower-of-cost-or-net-realizable-value method, if applicable. The cost formulas used. The carrying amount of inventories in classifications appropriate to the entity. An estimated amount of obsolete inventory included in the total inventory valuation. Answer (A) is incorrect because disclosures should include the accounting policies applied, such as the lower-of-cost-or-NRV method. Answer (B) is incorrect because disclosures should include the cost formulas used. Answer (C) is incorrect because disclosures should include the amounts for classifications of inventory appropriate to the entity. Answer (D) is correct. According to IAS 2, Inventories, disclosures about inventories include, for example, the accounting policies applied in measuring inventories, including the cost formulas used; total carrying amount; carrying amount for each classification appropriate to the entity; carrying amount of items carried at fair value minus costs to sell; amount of any reversal of writedowns recognized as income; reasons for such a reversal; and carrying amount of inventory pledged as security. Thus, the disclosures under IAS 2 include the carrying amount of inventories carried at NRV, not the amount of obsolete inventory.

[444] Gleim #: 3.154 -- Source: Publisher Subsequent measurement of trade receivables is at

A. B. C. D.

Fair value through profit or loss. Cost. Amortized cost. Fair value through equity. Answer (A) is incorrect because initial measurement of financial assets and liabilities is at fair value. Subsequent measurement of assets or liabilities held for trading and of certain other designated items is at fair value through profit or loss. Answer (B) is incorrect because unquoted equity instruments whose fair value is not reliably measurable are reported at cost. Answer (C) is correct. According to IAS 39, subsequent measurement of financial assets (including derivatives that are assets) is at fair value with certain exceptions. Loans and receivables and held-to-maturity investments are measured at amortized cost using the effective interest method. Unquoted equity instruments whose fair value is not reliably measurable are reported at cost. Answer (D) is incorrect because a gain or loss on an available-for-sale financial asset is recognized directly in equity until the asset is derecognized. Available-for-sale financial assets and liabilities are nonderivatives not designated as such or not falling within one of the other categories: (1) items at fair value through profit or loss, (2) held-to-maturity items, or (3) loans and receivables.

[445] Gleim #: 3.155 -- Source: CIA 1194 IV-19 A new machine has an initial cost of 300,000, an estimated useful life of 2,000 hours of use over a 3-year period, and an estimated residual value of 70,000. Usage rates are estimated as 500 hours in the first year, 700 hours in the second year, and 800 hours in the third year. Depreciation expense in year two under the sum-of-the-units method of depreciation will be

A. B. C. D.

57,500 75,000 80,500 105,000

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Answer (A) is incorrect because 57,500 is the depreciation expense for year one. Answer (B) is incorrect because 75,000 is the expense for year one calculated without subtracting the residual value. Answer (C) is correct. Depreciation expense equals cost minus residual value, times the quotient of estimated hours of use in year two divided by the total estimated hours of use. Thus, depreciation expense is 80,500 [(300,000 70,000) (700 hours 2,000 hours)]. Answer (D) is incorrect because 105,000 results from not subtracting the residual value. [446] Gleim #: 3.156 -- Source: CIA 595 IV-9 What is the journal entry recorded upon the sale of an item of property, plant, and equipment (PPE) that was sold for cash in excess of its carrying amount?

A. No journal entry is required. B. Debit cash Debit accumulated depreciation Debit income on disposal of PPE Credit PPE C. Debit cash Debit PPE Credit accumulated depreciation Credit income on disposal of PPE D. Debit cash Debit accumulated depreciation Credit PPE Credit income on disposal of PPE Answer (A) is incorrect because depreciation must be taken up to the date of disposition and all amounts relating to the retired asset should be eliminated. Answer (B) is incorrect because the gain should be recorded as a credit. Answer (C) is incorrect because the PPE account should be credited, and accumulated depreciation should be debited. Answer (D) is correct. The journal entry to record the sale of an item of PPE for cash in excess of its carrying amount should debit the cash account to record the sale proceeds received. Accumulated depreciation should be eliminated by debiting an amount equal to depreciation accumulated up to the start of the current accounting period plus any depreciation that has accumulated between the start of the current period and the date of disposal. Finally, the PPE account should be credited to eliminate the original cost of the asset. The gain should be recorded as a credit and recognized as income on the income statement. [447] Gleim #: 3.157 -- Source: CIA 595 IV-13 An entity had 1,000 units of opening inventory that cost 10 per unit. On May 1, 1,000 units were purchased at a cost of 11 each, and on September 1 another 1,000 units were purchased at a cost of 12 each. If 2,000 units were sold during the year, the company will report cost of goods sold of <List A> if the <List B> method of inventory valuation is used.

List A A. B. C. D. 22,000 23,000 21,000 22,000 LIFO

List B Weighted average FIFO FIFO

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Answer (A) is incorrect because cost of goods sold is 22,000 under the weighted-average method. Under LIFO, cost of goods sold is 23,000 (12,000 + 11,000). The 2,000 most recently purchased units are presumed to have been sold. Answer (B) is incorrect because the weighted-average unit cost of all items available for sale is 11 [(10,000 + 11,000 + 12,000) 3,000]. Given that 2,000 units were sold, cost of goods sold is 22,000 (2,000 11) under this method. Answer (C) is correct. Under FIFO, the first items purchased are presumed to be the first sold. Given that 3,000 units were available and 2,000 units were sold, FIFO cost of goods sold must have been 21,000 [(1,000 10) BI + (1,000 11) May 1 purchase]. Answer (D) is incorrect because FIFO cost of goods sold is 21,000. Under the weighted-average method, cost of goods sold is 22,000. [448] Gleim #: 3.158 -- Source: CIA 595 IV-17 An entity sold a depreciable asset in the middle of the fifth year of its estimated 10-year useful life. The original cost of the asset was 100,000, and it was being depreciated on the straight-line basis. If the asset was sold for 80,000, the gain on the sale will be

A. B. C. D.

20,000 25,000 30,000 35,000 Answer (A) is incorrect because 20,000 omits depreciation for the first half of the fifth year. Answer (B) is correct. The gain on the sale is the difference between the sale proceeds and the undepreciated cost of the asset. Depreciation must be taken up to the time of sale. Assuming that residual value is 0, annual depreciation is 10,000 (100,000 10 years). Thus, the gain is 25,000 {80,000 [100,000 (4.5 years 10,000)]}. Answer (C) is incorrect because 30,000 results if 5 full years of depreciation are taken. Answer (D) is incorrect because 35,000 results from subtracting accumulated depreciation from the sale proceeds.

[449] Gleim #: 3.159 -- Source: CIA 595 IV-22 Which of the following changes in accounting policies resulting from a significant change in the expected pattern of economic benefit will increase net profit?

A. B. C. D.

A change from FIFO to LIFO inventory valuation when costs are rising. A change from FIFO to weighted-average inventory valuation when costs are falling. A change from accelerated to straight-line depreciation in the later years of the depreciable lives of the assets. A change from straight-line to accelerated depreciation in the early years of the depreciable lives of the assets.

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Answer (A) is incorrect because a change to LIFO is not allowed. Answer (B) is correct. According to IAS 16, Property, Plant, and Equipment , a change in depreciation method resulting from a significant change in the expected pattern of economic benefits is accounted for as a change in estimate, that is, prospectively. In a period of falling costs, FIFO results in higher cost of goods sold than the weighted-average method. FIFO includes the higher, earlier costs in cost of goods sold, whereas the weighted-average method averages the later, lower costs with the higher, earlier costs. Thus, a change from FIFO to weighted-average costing reduces cost of goods sold and increases reported net profit. Answer (C) is incorrect because, in the later years of the depreciable life of an asset, accelerated depreciation results in lower depreciation expense than does the straight-line method. A change to straight line increases depreciation expense and reduces reported net profit. Answer (D) is incorrect because, in the early years of the depreciable life of an asset, straight-line depreciation results in lower depreciation expense than accelerated depreciation. A change to accelerated depreciation increases depreciation expense and reduces reported net profit. [Fact Pattern #27] An entity had the following account balances in the pre-closing trial balance:

Opening inventory Closing inventory Purchases Transportation-in Purchase discounts Purchase allowances Returned purchases

100,000 150,000 400,000 6,000 40,000 15,000 5,000

[450] Gleim #: 3.160 -- Source: CIA 1195 IV-5 (Refers to Fact Pattern #27) The entity had net purchases for the period of

A. B. C. D.

340,000 346,000 370,000 376,000 Answer (A) is incorrect because 340,000 omits transportation-in from the calculation. Answer (B) is correct. Purchase discounts, allowances, and returns are subtractions from purchases because they are reductions of cost. Transportation-in is an addition because it increases cost. Thus, net purchases equals 346,000 (400,000 + 6,000 40,000 15,000 5,000). Answer (C) is incorrect because 370,000 omits transportation-in and adds, rather than subtracts, purchase allowances. Answer (D) is incorrect because 376,000 adds, rather than subtracts, purchase allowances.

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[Fact Pattern #28] An entity has 8,000 units in inventory on January 1, valued at 10 per unit. During the year, the entity sold 25,000 units and purchased inventory as follows:

Date April 1 July 1 October 1

Quantity Purchased 15,000 units 10,000 units 12,500 units

Unit Price 8 9 10

[451] Gleim #: 3.161 -- Source: CIA 1195 IV-18 (Refers to Fact Pattern #28) If the entity uses the weighted-average method of inventory valuation, cost of goods sold for the period will be

A. B. C. D.

186,978 197,000 228,023 235,000 Answer (A) is incorrect because 186,978 is the value of ending inventory under the weighted-average method. Answer (B) is incorrect because 197,000 is the ending inventory under the FIFO method. Answer (C) is correct. Under the weighted-average method, the weighted-average cost per unit is multiplied by the number of units sold to determine the cost of goods sold for the period. The total units available for sale equaled 45,500 (8,000 + 15,000 + 10,000 + 12,500). The total cost of all units available for sale was 415,000 [(8,000 10) + (15,000 8) + (10,000 9) + (12,500 10)]. Thus, the weighted-average cost per unit of inventory was 9.1209 (415,000 45,500), and cost of goods sold was 228,023 (25,000 9.1209). Answer (D) is incorrect because 235,000 is the cost of goods sold under the LIFO method.

[452] Gleim #: 3.162 -- Source: CIA 1196 IV-8 The following information is available for an entity for the quarter ended March 31, of the current year: Merchandise inventory, as of January 1 of the current year Sales Purchases

30,000 200,000 190,000

The gross profit margin is normally 20% of sales. What is the estimated cost of the merchandise inventory at March 31, of the current year?

A. B. C. D.

20,000 40,000 60,000 180,000

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Answer (A) is incorrect because 20,000 is the difference between sales for the period and cost of goods available for sale. Answer (B) is incorrect because 40,000 is the amount of gross profit. Answer (C) is correct. The gross profit margin percentage is given as 20% of sales. Hence, cost of goods sold must have been 160,000 [200,000 sales (1.0 .2)]. The estimated cost of the inventory at March 31, 2004 is computed as follows:

Inventory, 1/1 Purchases Cost of goods available for sale, 3/31 Estimated cost of goods sold Estimated inventory at 3/31

30,000 190,000 220,000 (160,000) 60,000

Answer (D) is incorrect because 180,000 results from subtracting the gross profit from cost of goods available for sale. [453] Gleim #: 3.163 -- Source: CIA 596 IV-27 On January 1 of year 1, an entity purchased a piece of equipment for 250,000 that was originally estimated to have a useful life of 10 years with no residual value. Depreciation has been recorded for 3 years on a straight-line basis. On January 1 of year 4, the estimated useful life was revised so that the equipment is considered to have a total life of 20 years. Assume that the depreciation method and the useful life for financial reporting and tax purposes are the same. The depreciation expense in year 4 on this equipment would be

A. B. C. D.

8,750 10,294 12,500 14,706 Answer (A) is incorrect because 8,750 is the result of depreciating the remaining carrying amount over 20 years rather than the remaining 17 years. Answer (B) is correct. In year 4, the carrying amount at the start of the period will be amortized over the revised estimated years of useful life. The depreciation recognized during years 1 through 3 was 75,000 [3 years (250,000 10)]. Thus, the carrying amount at the beginning of year 4 was 175,000, and year four depreciation based on the revised estimated useful life is 10,294 [175,000 (20 3)]. Answer (C) is incorrect because 12,500 results from accounting for the change in estimate retroactively. Answer (D) is incorrect because 14,706 results from depreciating the original carrying amount over the revised estimate of remaining useful life.

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[Fact Pattern #29] An entity had the following opening and closing inventory balances during the current year:

1/1 Finished goods Raw materials Work-in-progress The following transactions and events occurred during the current year: 300,000 of raw materials were purchased, of which 20,000 were returned because of defects. 600,000 of direct labor costs were incurred. 750,000 of production overhead costs were incurred. 90,000 105,000 220,000

12/31 260,000 130,000 175,000

[454] Gleim #: 3.164 -- Source: CIA 596 IV-14 (Refers to Fact Pattern #29) The cost of goods sold for the current year ended December 31 would be

A. B. C. D.

1,480,000 1,500,000 1,610,000 1,650,000 Answer (A) is correct. Cost of goods sold equals cost of goods produced (CGP) adjusted for the change in finished goods. CGP equals the sum of raw materials used, direct labor costs, and production overhead, adjusted for the change in work-in-progress. Raw materials used equals 255,000 (105,000 BI + 300,000 purchases 20,000 returns 130,000 EI). Thus, CGP equals 1,650,000 (255,000 RM + 600,000 DL + 750,000 OH + 220,000 BWIP 175,000 EWIP), and CGS equals 1,480,000 (1,650,000 CGP + 90,000 BFG 260,000 EFG). Answer (B) is incorrect because 1,500,000 results from not subtracting purchase returns when calculating raw materials used. Answer (C) is incorrect because 1,610,000 fails to deduct the ending balance of raw materials when calculating raw materials used. Answer (D) is incorrect because 1,650,000 is the cost of goods produced.

[455] Gleim #: 3.165 -- Source: CIA 596 IV-15 (Refers to Fact Pattern #29) Without prejudice to your answer to any other question, assume that cost of goods sold for the current year ended December 31 is 2,000,000. Inventory turnover on total inventory for the entity would be

A. B. C. D.

2.04 times. 3.54 times. 4.08 times. 4.82 times.

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Answer (A) is incorrect because 2.04 times results from adding all inventory balances, opening and closing, to obtain the denominator of the turnover ratio. Answer (B) is incorrect because 3.54 times results from using the year-end inventory balances only. Answer (C) is correct. Inventory turnover is the ratio of cost of goods sold to the average inventory balance. The total average inventory is 490,000 [(90,000 BFG + 105,000 BRM + 220,000 BWIP + 260,000 EFG + 130,000 ERM + 175,000 EWIP) 2]. Hence, total inventory turnover is 4.08 times (2,000,000 assumed CGS 490,000 average total inventory). Answer (D) is incorrect because 4.82 times results from using the opening inventory balances only. [456] Gleim #: 3.166 -- Source: CIA 596 IV-16 (Refers to Fact Pattern #29) If the entitys raw materials inventory as of December 31 of the current year (ending inventory) was miscounted and the true figure was higher than 130,000, one effect on the year-end financial statements would be that

A. B. C. D.

Net profit is overstated. Cost of goods sold is overstated. Working capital is overstated. Cost of goods produced is understated. Answer (A) is incorrect because, if the ending inventory of raw materials is understated, cost of goods sold is overstated, and net income is understated. Answer (B) is correct. If the ending inventory of raw materials is understated, raw materials used is overstated, cost of goods produced is overstated, and cost of goods sold is overstated. Answer (C) is incorrect because working capital is higher when the balances of current assets are higher. If the raw materials inventory balance is understated, working capital will also be understated. Answer (D) is incorrect because, if the ending inventory of raw materials is understated, raw materials used is overstated, and cost of goods produced is overstated.

[457] Gleim #: 3.167 -- Source: CIA 593 IV-42 A plot of land is acquired in exchange for 250,000 cash and a noninterest-bearing note with a face amount of 1,000,000 on January 1 of the current year. The 1,000,000 is payable in installments of 250,000 each, with the first installment due December 31 of the current year. With regard to imputing interest on this note, (1) what market rate should be used to account for interest for the current year and (2) what should be done in future years when there is a change in prevailing interest rates?

(2) Impact of Change in (1) Market Rate Used to Compute Interest Expense for the current year A. B. C. D. Rate prevailing at January 2 Rate prevailing at January 2 Rate prevailing at December 31 Rate prevailing at December 31 Prevailing Interest Rates in Future Periods on Rate Used to Account for This Note Ignore change in rate Use new market rate Ignore change in rate Use new market rate

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Answer (A) is correct. Determination of the imputed interest rate is made at the time the debt instrument is issued. Subsequent to initial recognition, most financial liabilities are measured at amortized cost using the effective interest method. Exceptions are those (1) classified as at fair value through profit or loss or (2) arising when a transfer of a financial asset does not qualify for derecognition or is accounted for on a continuing involvement basis (IAS 39). Consequently, a change in the prevailing market rate does not affect the measurement of the noninterest-bearing note given for the land. Answer (B) is incorrect because any subsequent changes in prevailing interest rates are ignored. Answer (C) is incorrect because determination of the imputed interest rate is made at the time the debt instrument is issued. Answer (D) is incorrect because determination of the imputed interest rate is made at the time the debt instrument is issued, and any subsequent changes in prevailing interest rates are ignored. [458] Gleim #: 3.168 -- Source: CIA 1193 IV-44 An entity issued a noninterest bearing note payable due in 1 year in exchange for land. The fair value of the land is not reliably determinable. Which of the following statements is true concerning the accounting for the transaction?

A. The land should be recorded at the future value of the note, and interest should be imputed at the prevailing rate on similar notes. B. No interest should be recognized on the note, and the land should be recorded at the present value of the note. C. Interest on the note should be imputed at the prime rate, and the land should be recorded at the discounted value of the note. D. Interest on the note should be imputed at the prevailing rate for similar notes, and the land should be recorded at the present value of the note. Answer (A) is incorrect because the value of the land will be overstated if it is recorded at future value; present value is the proper valuation. Answer (B) is incorrect because interest should be recognized on the note. Answer (C) is incorrect because the proper discount rate is the prevailing rate for similar notes, not necessarily the prime rate. Answer (D) is correct. When a financial liability is initially recognized, the entity should measure it at its cost, that is, the fair value of the consideration received. The fair value ordinarily is determined by reference to the transaction price or other market prices. If these prices are not reliably determinable, the fair value is estimated by discounting the future cash payments at an imputed rate equal to the prevailing market rate for a similar instrument (e.g., similar as to currency, term, and type of rate) of an issuer with a similar credit rating. [459] Gleim #: 3.169 -- Source: IIA, adapted Which must be part of any risk model involving inventory valuation?

A. B. C. D.

Product warranty policies. Vendor pricing policies. Inventory shrinkage expense. Annual sales forecasts. Answer (A) is incorrect because warranties are not a part of inventory valuation. Answer (B) is incorrect because vendor pricing policies have no effect on inventory valuation until goods are purchased. The price at the time of purchase is the only price that matters in inventory valuation, and changes in vendor pricing policies would not necessarily affect valuation. Answer (C) is correct. The amount of inventory loss through shrinkage directly affects inventory valuation. Inventory shrinkage must be considered in risk models involving inventory valuation. Answer (D) is incorrect because sales forecasts do not affect inventory valuation.

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[460] Gleim #: 3.170 -- Source: IIA, adapted On January 1, a company has no opening inventory balance. The following purchases are made during the year: Units Purchased January 1 April 1 July 1 October 1 5,000 5,000 5,000 5,000 Unit Cost $10.00 9.00 8.00 7.50

There are 10,000 units in inventory on December 31. If the company uses the first in, first out (FIFO) method of inventory valuation, the ending inventory balance will be

A. B. C. D.

$77,500 $85,000 $86,250 $95,000 Answer (A) is correct. Under first-in, first-out (FIFO) inventory valuation, the 10,000 units in ending inventory are assumed to have been the most recent items purchased. The cost of the most recent 10,000 units purchased is : (5,000 units $7.50) + (5,000 units $8) = $77,500. Answer (B) is incorrect because this solution is the ending inventory balance under the specific identification method if the units remaining in inventory at year end were identified as having been purchased on April 1 and July 1: (5,000 units $9) + (5,000 units $8) = $85,000. Answer (C) is incorrect because this solution is the ending inventory balance under the average cost method. The average cost of all items purchased is used to calculate the ending inventory balance. The average cost of items purchased is: [$10 (5,000) + $9 (5,000) + $8 (5,000) + $7.50 (5,000)] 20,000 = $8.625 per unit so 10,000 units are assigned a value of $86,250. Answer (D) is incorrect because this solution is the ending inventory balance under the last-in, first-out (LIFO) method of inventory valuation. The most recent items purchased are assumed to be sold first, so the items remaining in inventory are assigned the cost of the earliest purchases: (5,000 units $10) + (5,000 units $9) = $95,000.

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[Fact Pattern #30] At the end of the accounting period, an entity has the partially completed financial statements shown as follows.

Income Statement: Sales Cost of goods sold Gross profit Administrative expense Depreciation expense Profit before interest and tax Interest expense Profit before tax Tax expense Profit Balance Sheet: Current assets Other assets Total assets Current liabilities Long-term debt Equity Total liabilities and equity Additional Information: Gross profit percentage = 30% Tax rate = 40% Annual interest cost on long-term debt = 10% Return on total assets = 3% Fixed assets originally cost 500,000 and are being depreciated over 10 years on a straight-line basis. Working capital = 2,000,000 [461] Gleim #: 3.171 -- Source: CIA 1195 IV-12 (Refers to Fact Pattern #30) The entity had sales for the period of

40,000

100,000

300,000

1,000,000

A. B. C. D.

891,667 1,100,000 1,188,890 1,466,667 Answer (A) is incorrect because 891,667 uses a gross profit percentage of 40%. Answer (B) is incorrect because 1,100,000 calculates profit before tax as profit divided by the tax rate and also calculates sales as gross profit divided by the tax rate. Answer (C) is correct. Gross profit equals 30% of sales. Thus, dividing gross profit by 30% yields sales. Gross profit equals profit before interest and tax (PBIT) plus administrative expense (given as 40,000) and depreciation (500,000 fixed assets 10 years = 50,000). Interest equals 10% of the long-term debt, or 100,000 (10% 1,000,000). Profit before tax equals 166,667 [100,000 profit (1.0 40% tax rate)]. Hence, PBIT must equal 266,667 (166,667 + 100,000), and gross profit must be 356,667 (266,667 PBIT + 40,000 administrative expense + 50,000 depreciation). Sales is therefore 1,118,890 (356,667 gross profit 30% gross profit rate). Answer (D) is incorrect because 1,466,667 calculates profit before tax as profit divided by the tax rate.

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[462] Gleim #: 3.172 -- Source: CIA 1195 IV-13 (Refers to Fact Pattern #30) The entity has current assets of

A. B. C. D.

1,000,000 3,033,333 3,333,333 3,633,333 Answer (A) is incorrect because 1,000,000 equals working capital minus long-term debt. Answer (B) is correct. Return on total assets (3%) equals profit (100,000) divided by total assets. Consequently, total assets equals 3,333,333 (100,000 .03). Current assets must therefore equal 3,033,333 (3,333,333 total assets 300,000 other assets). Answer (C) is incorrect because 3,333,333 is the amount of total assets. Answer (D) is incorrect because 3,633,333 is the sum of total and other assets.

[463] Gleim #: 3.173 -- Source: CMA 1290 1-30 Lawson Ltd. has the opportunity to increase annual sales 100,000 by selling to a new, riskier group of customers. Based on sales, the uncollectible expense is expected to be 15%, and collection costs will be 5%. Manufacturing and selling expenses are 70% of sales, and the effective tax rate is 40%. If Lawson accepts this opportunity, the after-tax profit will increase by

A. B. C. D.

4,000. 6,000. 10,000. 9,000. Answer (A) is incorrect because after-tax profit will increase by 6,000. Answer (B) is correct. Manufacturing and selling costs exclusive of bad debts equal 70% of sales. Hence, the gross profit on the 100,000 increase in sales will be 30,000 (30% 100,000). Assuming 15,000 of bad debts and 5,000 of collection expense, the increase in pre-tax profit will be 10,000 (30,000 20,000). Consequently, after-tax profit will increase by 6,000 [10,000 (40% 10,000)]. Answer (C) is incorrect because after-tax profit will increase by 6,000. Answer (D) is incorrect because after-tax profit will increase by 6,000.

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[Fact Pattern #31] An entity has the following income statements: 20X2 Sales Cost of goods sold Gross profit Selling and administrative expense Depreciation expense Profits before interest and taxes Interest expense Profit before taxes Income tax (50%) Profit Selected balance sheet items are as follows: 20X2 Year-end Accounts receivable Accounts payable Assume a 365-day year in any calculations. [464] Gleim #: 3.174 -- Source: CIA 1196 IV-37 (Refers to Fact Pattern #31) In 20X2, the entity had cash provided by operations of 300,000 250,000 20X1 Year-end 200,000 275,000 1,500,000 800,000 700,000 62,000 50,000 688,000 100,000 588,000 294,000 294,000 20X1 1,400,000 750,000 650,000 60,000 50,000 540,000 100,000 440,000 220,000 220,000

A. B. C. D.

219,000 244,000 344,000 469,000 Answer (A) is correct. Cash provided by operations equals profit, plus depreciation, minus the increase in accounts receivable, minus the decrease in accounts payable. The cash provided is 219,000 [294,000 + 50,000 (300,000 200,000) (275,000 250,000)]. An increase in receivables is a noncash component of profit. A decrease in accounts payable is added when adjusting cost of goods sold to reflect cash paid to suppliers. Thus, it is subtracted when adjusting profit to arrive at cash provided by operations. Answer (B) is incorrect because 244,000 does not consider the changes in accounts receivable and payable and subtracts depreciation. Answer (C) is incorrect because 344,000 does not consider the changes in accounts receivable and payable. Answer (D) is incorrect because 469,000 adds rather than subtracts the increase in receivables and the decrease in payables.

[465] Gleim #: 3.175 -- Source: CIA 1196 IV-38 (Refers to Fact Pattern #31) Based on the 20X2 year-end balance of accounts receivable and the 20X2 income statement, the company had an average collection period for 20X2 of

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A. B. C. D.

49 days. 52 days. 73 days. 78 days. Answer (A) is incorrect because 49 days uses accounts receivable from 20X1 instead of 20X2. Answer (B) is incorrect because 52 days is the average collection period for 20X1. Answer (C) is correct. The average collection period for 20X2 is 73 days [300,000 accounts receivable (1,500,000 sales 365 days)]. Answer (D) is incorrect because 78 days uses 20X1 annual sales.

[466] Gleim #: 3.176 -- Source: Publisher The effective portion of a gain arising from an increase in the fair value of a derivative is included in profit or loss in the period of change if the derivative is appropriately designated and qualifies as a hedge of

A. B. C. D.

A net investment in a foreign entity. The variable cash flows of a forecast transaction. An unrecognized firm commitment. The variable cash flows of a recognized asset. Answer (A) is incorrect because the effective portion of gains and losses on this hedge is reported as a component of equity. Answer (B) is incorrect because the effective portion of gains and losses on these hedges is included in equity. Answer (C) is correct. A fair value hedge includes a hedge of an exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment. Such a hedge minimizes the risk associated with fixed cash flows. Gains and losses arising from changes in fair value of a derivative classified as a fair value hedge are included in the determination of profit or loss in the period of change. They are offset by losses or gains on the hedged item attributable to the risk being hedged. Thus, profit or loss of the period of change is affected only by the net gain or loss attributable to the ineffective portion of the hedge. Answer (D) is incorrect because the effective portion of gains and losses on these hedges is included in equity.

[467] Gleim #: 3.177 -- Source: Publisher Garcia Corporation has entered into a binding agreement with Hernandez Company to purchase 400,000 pounds of Colombian coffee at $2.53 per pound for delivery in 90 days. This contract is accounted for as a

A. B. C. D.

Financial instrument. Firm commitment. Forecast transaction. Fair value hedge. Answer (A) is incorrect because a financial instrument does not involve the delivery of a product. Answer (B) is correct. A firm commitment is an agreement with an unrelated party, binding on both parties and usually legally enforceable, that specifies all significant terms and includes a disincentive for nonperformance. Answer (C) is incorrect because a forecast transaction is a transaction that is expected to occur for which no firm commitment exists. Answer (D) is incorrect because the purchase commitment is an exposure to risk, not a hedge of an exposure to risk.

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[468] Gleim #: 3.178 -- Source: Publisher On October 1, 20X1, Bordeaux, Inc., a calendar-year-end firm, invested in a derivative designed to hedge the risk of changes in fair value of certain assets, currently valued at $1.5 million. The derivative is structured to result in an effective hedge. However, some ineffectiveness may result. On December 31, 20X1, the fair value of the hedged assets has decreased by $350,000; and the fair value of the derivative has increased by $325,000. Bordeaux should recognize a net effect on 20X1 profit or loss of

A. B. C. D.

$0 $25,000 $325,000 $350,000 Answer (A) is incorrect because the effect on profit or loss is equal to the ineffective portion of the hedge. Answer (B) is correct. A hedge of an exposure to changes in the fair value of a recognized asset or liability is classified as a fair value hedge. Gains and losses arising from changes in fair value of a derivative classified as a fair value hedge are included in the determination of profit or loss in the period of change. They are offset by losses or gains on the hedged item attributable to the risk being hedged. Thus, profit or loss of the period of change is affected only by the net gain or loss attributable to the ineffective aspect of the hedge. The ineffective portion is equal to $25,000 ($350,000 $325,000). Answer (C) is incorrect because the increase in the fair value of the derivative is a gross effect. Answer (D) is incorrect because the decrease in the fair value of the hedged assets is a gross effect.

[469] Gleim #: 4.1 -- Source: CIA 597 IV-21 Which of the following statements is true for a defined contribution postemployment benefit plan?

A. B. C. D.

The employer is required to contribute a certain amount each period based on the plans formula. The employer bears the risk of the plans investment performance. Postemployment benefits received by employees are defined by the plans formula. The employer and employees are required to contribute equal amounts to the fund. Answer (A) is correct. A defined contribution plan provides benefits in exchange for services, provides an account for each participant, and specifies how contributions are to be determined. Postemployment benefits depend only on contributions, returns on investment, and allocated forfeitures of other participants benefits. Thus, employees have the benefit of gain and the risk of loss. Answer (B) is incorrect because the employees bear the risk of the plans investment performance. Answer (C) is incorrect because, under a defined benefit plan, the postemployment benefits received by employees are defined by the plans formula. Answer (D) is incorrect because equal contributions are not required for a defined contribution plan.

[470] Gleim #: 4.2 -- Source: CIA 595 IV-16 The defined postemployment benefit obligation of an entity includes benefit obligations to <List A> employees at <List B> salary levels.

List A A. B. C. D. Vested Vested Vested and nonvested Vested and nonvested

List B Current Future Current Future

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Answer (A) is incorrect because the defined postemployment benefit includes both vested and nonvested benefits and is calculated at future levels. Answer (B) is incorrect because the defined postemployment benefit includes both vested and nonvested benefits and is calculated at future levels. Answer (C) is incorrect because the defined postemployment benefit includes both vested and nonvested benefits and is calculated at future levels. Answer (D) is correct. The measurement of a postemployment benefit obligation includes estimates of future salary increases, the benefits defined in the plan, the benefits arising from any constructive obligation beyond the terms of the plan, and estimates of future changes in state benefits that affect the level of plan benefits. The possibility that nonvested projected benefits will not vest is a factor in the measurement of the DBO, but it does not affect the existence of the obligation. [471] Gleim #: 4.3 -- Source: CIA 1189 IV-44 An employees right to obtain postemployment benefits regardless of whether (s)he remains employed is known as his/her

A. B. C. D.

Past service cost. Defined benefit plan. Vested benefits. Additional minimum liability. Answer (A) is incorrect because past service cost relates to benefits for employee service provided prior to the adoption or amendment of a defined benefit plan. Answer (B) is incorrect because a defined benefit plan provides a defined benefit based on one or more factors, such as level of compensation, years of service, or age. Answer (C) is correct. Vested benefits are those earned postemployment benefits owed to an employee that are not contingent upon the employees continued service. Whether benefits have vested affects the measurement of the employers defined benefit obligation but not its existence. Moreover, vesting affects the accounting for past service cost. Past service cost is amortized as an expense over the average period until the benefits are vested. Answer (D) is incorrect because, under IAS 19, the employer does not recognize an additional minimum liability.

[472] Gleim #: 4.4 -- Source: Publisher An employer sponsors a defined postemployment benefit plan. If the given amount of the present value of the defined benefit obligation exceeds the given amount of the fair value of plan assets, the defined benefit liability to be recognized in the balance sheet is greatest when the employer has

A. B. C. D.

Net unrecognized actuarial gains and no past service cost. Net unrecognized actuarial losses and no past service cost. Net unrecognized actuarial losses and unrecognized past service cost. No unrecognized actuarial gains or losses and unrecognized past service cost.

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Answer (A) is correct. The amount of the defined benefit liability recognized equals the present value of the defined benefit obligation at the balance sheet date, plus (minus) unrecognized actuarial gains (losses), minus unrecognized past service cost, minus the fair value of plan assets at the balance sheet date. If this amount is negative, it represents an asset. However, the maximum that may be recognized for such an asset is the sum of unrecognized actuarial losses, unrecognized past service cost, and the present value of future refunds from the plan or reductions in future contributions. Moreover, the application of this section should not result in a gain being recognized solely because of an actuarial loss or past service cost in the current period or in a loss being recognized solely because of an actuarial gain in the current period. Thus, if the excess of the DBO over the fair value of plan assets is constant, net unrecognized actuarial gains will increase the liability. Net unrecognized actuarial losses and unrecognized past service cost decrease the liability. Answer (B) is incorrect because net unrecognized actuarial losses decrease the liability. Answer (C) is incorrect because net unrecognized actuarial losses and unrecognized past service cost decrease the liability. Answer (D) is incorrect because net unrecognized actuarial gains increase the liability. [473] Gleim #: 4.5 -- Source: Publisher The following information relates to the activity of the defined postemployment benefit plan of Twain Publishers, Ltd.: Current service cost Expected return on plan assets Interest cost on defined benefit obligation Amortization of net actuarial loss Past service cost 120,000 30,000 40,000 10,000 5,000

Twains expense recognized in the income statement is

A. B. C. D.

120,000 135,000 140,000 145,000 Answer (A) is incorrect because 120,000 includes only the current service cost component. Answer (B) is incorrect because 135,000 excludes the amortization of the actuarial loss. Answer (C) is incorrect because 140,000 excludes the past service cost. Answer (D) is correct. Components of the expense are current service cost, interest cost, the expected return on plan assets, past service cost (recognition in full of vested amounts and amortization of nonvested amounts). Current service cost, interest cost, the amortization of actuarial loss, and the past service cost increase the expense. The expected return on plan assets decreases the expense. Current service cost Return on plan assets Interest cost Amortization of actuarial loss Past service cost Expense 120,000 (30,000) 40,000 10,000 5,000 145,000

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[474] Gleim #: 4.6 -- Source: Publisher At the start of its current fiscal year, Emper Corporation amended its defined postemployment benefit plan, resulting in an increase in the present value of the DBO. The benefits become vested after 6 years of service. Past service cost arising from the plan amendment includes 400,000 of benefits that are already vested and 200,000 of nonvested benefits. If the average period until vesting is 4 years, the minimum past service cost to be recognized in the first year is

A. B. C. D.

50,000 200,000 450,000 600,000 Answer (A) is incorrect because 50,000 is the periodic amortization of nonvested benefits. Answer (B) is incorrect because 200,000 is the amount of the nonvested benefits. Answer (C) is correct. Past service cost is the increase in the present value of the DBO related to prior employee service that arises in the current period from the introduction of, or an amendment to, postemployment benefits. Accordingly, 400,000 should be recognized immediately to reflect the vested benefits and amortization of the nonvested benefits equals 50,000 (200,000 4), a total of 450,000. Answer (D) is incorrect because 600,000 includes nonvested benefits not yet required to be amortized.

[475] Gleim #: 4.7 -- Source: Publisher At end of the year, Employers defined benefit obligation (DBO) was determined to be 1,500,000, which was 200,000 higher than had been expected. The defined benefit plans assets had a fair value of 1,250,000. No other actuarial gains and losses have occurred. If the average remaining working life is 20 years, the minimum required amortization of the unrecognized net actuarial gains and losses in the next year will be

A. B. C. D.

20,000 3,750 2,500 0 Answer (A) is incorrect because 20,000 is the result of using the full 200,000 liability loss without regard to the corridor amount and assumes an amortization period of 10 years instead of 20. Answer (B) is incorrect because 3,750 is the result of using 125,000 (10% 1,250,000 plan assets) as the corridor amount instead of 150,000. Answer (C) is correct. At a minimum, amortization of the cumulative unrecognized net actuarial gains and losses must be included as income or expense if, as of the close of the prior period, that unrecognized gain or loss exceeds 10% of the greater of the present fair value of the DBO or the fair value of plan assets. At year-end, the present value of the DBO was 200,000 greater than estimated (a 200,000 liability loss). Given that no other gain or loss has occurred, the unrecognized actuarial net loss to be amortized beginning next year is 200,000. The corridor amount is 150,000 (10% of the greater of 1,500,000 present value of the DBO or 1,250,000 fair value of plan assets). The amount outside the corridor is 50,000 (200,000 150,000), and the amount to be amortized is therefore 2,500 (50,000 20 years of average remaining working life). Answer (D) is incorrect because 50,000 of the liability loss must be amortized over the average remaining working life beginning the year following the loss.

[476] Gleim #: 4.8 -- Source: Publisher For an entity with a defined postemployment benefit plan, the fair value of plan assets at the beginning of the year was 500,000. No unrecognized net cumulative actuarial gain or loss existed. On the last day of the fiscal year, the fair value of plan assets was 620,000. Benefits paid equaled 100,000, and the entity made 120,000 in contributions. The discount rate was 10%, and the expected long-term rate of return on plan assets was 12%. The actual return on plan assets was

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A. B. C. D.

50,000 60,000 75,000 100,000 Answer (A) is incorrect because 50,000 equals 10% of the beginning fair value. Answer (B) is incorrect because 60,000 equals 12% of the beginning fair value. Answer (C) is incorrect because 75,000 is a nonsense number. Answer (D) is correct. The actual return on plan assets is equal to the difference between the fair value of plan assets at the beginning and the end of the year adjusted for contributions and benefits paid. Thus, the actual return is 100,000. FV, end of year Benefits paid Contributions FV, beginning of year Actual return 620,000 100,000 (120,000) (500,000) 100,000

[477] Gleim #: 4.9 -- Source: Publisher An entity that sponsors a defined benefit postemployment benefit plan has discontinued a segment of its business. As a result, the employees of that segment will not be able to earn additional benefits. On the date of the discontinuance, the present value of the DBO was 10,000,000, the fair value of the plan assets was 8,500,000, the net unrecognized actuarial gain was 500,000, and the unrecognized past service cost was 100,000. The effect of the discontinuance was to reduce the present value of the DBO by 10%. The portions of the unrecognized actuarial gain and past service cost related to the portion of the DBO that was eliminated also equaled 10%. Accordingly, the entity should recognize what net defined benefit liability immediately after the discontinuance?

A. B. C. D.

410,000 860,000 900,000 950,000 Answer (A) is incorrect because 410,000 omits the remaining unrecognized actuarial gain. Answer (B) is correct. A curtailment arises from a reduction in covered employees or amendment of the plan to reduce benefits for future service. A settlement is a transaction that eliminates the DBO for part or all of plan benefits. When a curtailment or settlement occurs, the gain or loss recognized encompasses the change in the present value of the DBO, the change in the fair value of plan assets, and previously unrecognized related actuarial gains and losses and past service cost. Thus, the present value of the DBO after the curtailment was 9,000,000 [10,000,000 (10% 10,000,000)]. The fair value of plan assets was given as 8,500,000. The unrecognized actuarial gain was reduced to 450,000. The unrecognized past service cost was reduced to 90,000. Accordingly, the defined benefit liability immediately after the discontinuance was 860,000 (9,000,000 8,500,000 + 450,000 90,000). Answer (C) is incorrect because 900,000 is 10% of the present value of the remaining DBO. Answer (D) is incorrect because 950,000 omits past service cost from the calculation.

[478] Gleim #: 4.10 -- Source: Publisher IFRS 2, Share-Based Payment, normally requires entities to account for their share-based employee compensation plans in accordance with which of the following methods?

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Fair-ValueBased Method A. B. C. D. Yes Yes No No

Intrinsic-ValueBased Method Yes No Yes No

Answer (A) is incorrect because the intrinsic-value method is allowed only in rare cases. Answer (B) is correct. Entities must account for share-based employee compensation plans in accordance with the fair-valuebased method except in the rare cases in which the fair value of the equity instruments is not reliably measurable at the measurement date (the grant date for transactions with employees and those providing similar services). In these rare cases, IFRS 2 requires entities to account for these plans in accordance with the intrinsic-value-based method. Answer (C) is incorrect because the intrinsic-value method is allowed only in rare cases. Answer (D) is incorrect because the intrinsic-value method is allowed only in rare cases. [479] Gleim #: 4.11 -- Source: Publisher The measurement date in accounting for shares issued to employees in share option plans accounted for in accordance with the fair value method prescribed by IFRS 2 is

A. B. C. D.

The date on which options are granted to specified employees. The earliest date on which both the number of shares to be issued and the option price are known. The date on which the options are exercised by the employees. The date the corporation forgoes alternative use of the shares to be sold under option. Answer (A) is correct. Under the fair-value-based method prescribed by IFRS 2, compensation expense is measured at the grant date. This expense is based on the fair value of the award at that date and recognized over the vesting period, the period over which the vesting conditions are expected to be satisfied. Answer (B) is incorrect because the earliest date on which both the number of shares to be issued and the option price are known, the date on which the options are exercised by employees, and the date the entity forgoes alternative use of the shares to be sold under option may coincide with, but do not define, the measurement date. Answer (C) is incorrect because the earliest date on which both the number of shares to be issued and the option price are known, the date on which the options are exercised by employees, and the date the entity forgoes alternative use of the shares to be sold under option may coincide with, but do not define, the measurement date. Answer (D) is incorrect because the earliest date on which both the number of shares to be issued and the option price are known, the date on which the options are exercised by employees, and the date the entity forgoes alternative use of the shares to be sold under option may coincide with, but do not define, the measurement date.

[480] Gleim #: 4.12 -- Source: CIA 1195 III-58 On January 2, year 1, Kine Co. granted Morgan, its president, share options to buy 1,000 shares of Kines $10 par common stock. The options call for a price of 20 per share and are exercisable for 3 years following the grant date. Morgan exercised the options on December 31, year 1. The market price of the shares was 50 on January 2, year 1 and 70 on the following December 31. If the intrinsic value-based method is followed because the fair value of the options is not reliably measurable, by what net amount should equity increase as a result of the grant and exercise of the options?

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A. B. C. D.

20,000 30,000 50,000 70,000 Answer (A) is correct. The measurement date is January 2, year 1. At that date, the intrinsic value of the options is 30,000 [1,000 shares (50 market price 20 option price)]. This 30,000 will be recorded as both compensation expense and options outstanding. The net effect on equity is 0. When the options are exercised, the 20,000 (1,000 shares 20 exercise price) cash received and the 30,000 options outstanding will be allocated to share capital as 10,000 common stock and 40,000 additional paid-in capital. The net effect on equity will be a 20,000 increase. Answer (B) is incorrect because 30,000 is the amount of compensation expense. Answer (C) is incorrect because 50,000 is the increase in the equity without regard to the compensation expense. Answer (D) is incorrect because 70,000 results from calculating the increase in equity using the share price on the exercise date.

[481] Gleim #: 4.13 -- Source: Publisher On January 1, year 1, International Entity entered into an equity-settled share-based payment transaction with its senior executives. This award of 1,000 share options has a four-year vesting period. The market prices of the options and the related shares on the grant date are 20 and 80, respectively. The exercise price is 85. Assuming that the vesting conditions were not met for 100 of the options because of unexpected events in year 4, the entry to debit option expense at

A. B. C. D.

December 31, year 4 is for 5,000. December 31, year 3 is for 4,500. December 31, year 2 is for 5,000. January 1, year 1 is for 20,000. Answer (A) is incorrect because the year 4 expense is 3,000 [20,000 total expected 15,000 recognized in years 1-3 (100 20) not vested]. Answer (B) is incorrect because no retrospective adjustment is made. The year 3 entry would have been 5,000 based on a then-expected total expense of 20,000. Answer (C) is correct. The fair value of each share option is determined at the measurement date, which is the grant date for transactions with employees and others providing similar services. Thus, the fair value of each share option was set at its market price of 20 on January 1, year 1. The periodic expense varies only with the expected number of equity instruments expected to vest. Because the events causing 100 options not to vest occurred unexpectedly in year 4, the entity presumably expected at each balance sheet date for the first three years of the vesting period that all options would vest. Total expected expense was therefore 20,000, and the proportional expense recognized in each of the first three years was 5,000 [(1,000 options 20) 4 years]. Answer (D) is incorrect because 20,000 would have been recognized at January 1, year 1 if the options had vested immediately.

[482] Gleim #: 4.14 -- Source: CIA 1195 IV-28 If a lease agreement transfers substantially all of the risks and rewards of ownership of the asset to the lessee, the asset amount is recognized on the lessees records as a(n) <List A> asset, and the lease is classified as a <List B> lease.

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List A A. B. C. D. Tangible Intangible Tangible Intangible

List B Finance Finance Operating Operating

Answer (A) is correct. When a lease agreement transfers the risks and rewards of ownership of the asset to the lessee, the lease is treated as a finance lease because the transaction is in essence an installment purchase. Accordingly, the lessee records a depreciable asset and a liability. Moreover, IAS 38, Intangible Assets, specifically does not apply to leases that are within the scope of IAS 17, Leases. A finance lease is therefore regarded as a tangible asset. Answer (B) is incorrect because the recorded asset is a tangible asset. Answer (C) is incorrect because, if it transfers substantially all of the risks and rewards of ownership, the lease is a finance lease. Answer (D) is incorrect because, if it transfers substantially all of the risks and rewards of ownership, the lease is a finance lease. [483] Gleim #: 4.15 -- Source: CIA 596 IV-32 Finance and operating leases differ in that the lessor

A. Obtains use of the asset only under a finance lease. B. Is using the lease as a source of financing only under an operating lease. C. Makes rent payments that are actually installment payments constituting a payment of both principal and interest only under a finance lease. D. Finances the transaction through the leased asset only under a finance lease. Answer (A) is incorrect because the lessee obtains use of the asset. Answer (B) is incorrect because the lessee uses the lease as a source of financing under a finance lease, not an operating lease. Answer (C) is incorrect because the lessee makes payments to the lessor. Answer (D) is correct. A lease is a rental or sub-purchase arrangement between a lessor (the owner or seller of the property) and a lessee (the renter or purchaser). The issue in all leases is whether the risks and rewards of ownership have been transferred from the lessor to the lessee; if so, the lease should be accounted for as a sale-purchase, i.e., a finance lease. If the risks and rewards of ownership have not transferred, the lease is a rental arrangement and is called an operating lease. In effect, the lessor provides financing for an installment purchase, and the lessees payments include both principal and interest components. [484] Gleim #: 4.16 -- Source: CIA 595 IV-27 Which of the following statements about a finance lease is false?

A. B. C. D.

The lessor capitalizes the net investment in the lease. The lessor records the leased item as an asset. The lessee records depreciation or finance cost allowance on the leased asset. The lease arrangement represents a form of financing.

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Answer (A) is incorrect because, under a finance lease, the lessor recognizes a net receivable equal to the net investment in the lease: gross investment (minimum lease payments from the lessors perspective plus unguaranteed residual value) discounted at the interest rate implicit in the lease. Answer (B) is correct. When a transaction meets the criteria of a finance lease, the lessor removes the leased item from the books and records lease payments receivable regardless of whether the lessor is a manufacturer or dealer. The lessee records and depreciates the leased item under a finance lease. Answer (C) is incorrect because the lessee records depreciation on the leased asset under a finance lease. This process is separate from the accounting for the lease obligation. Answer (D) is incorrect because, in essence, the leased asset is being purchased when a lease meets the criteria for capitalization. Hence, the lease agreement represents a form of financing. [485] Gleim #: 4.17 -- Source: CIA 596 IV-31 Which of the following leases ordinarily should be classified as a finance lease by the lessee? Lease A Lease B Lease C Lease D Contains a bargain purchase option? Lease term is for the major part of the economic life of the leased asset Present value of the minimum lease payments is substantially all of the fair value of the leased asset Leased asset usable only by lessor without major modification

Yes

No

No

No

No

No

Yes

No

No

No

No

Yes

No

Yes

Yes

No

A. B. C. D.

Lease A only. Lease B only. Leases A, C, and D. Leases C and D only. Answer (A) is incorrect because Leases C and D are also finance leases. Answer (B) is incorrect because B is the only operating lease in the set. If it were usable by the lessee (not the lessor) without major modification, it would normally be classified as a finance lease. Answer (C) is correct. A lease should be classified as a finance lease by a lessee if it transfers substantially all of the risks and rewards of ownership. A lease is classified at its inception. It normally is classified as a finance lease if, for example, (1) the lease provides for the transfer of ownership of the leased asset by the end of the lease term; (2) the lease contains a bargain purchase option, i.e., the lessee has the option to purchase at a price expected to be sufficiently below the fair value of the exercise date that, at the leases inception, exercise is reasonably certain; (3) the lease term is for the major part of the economic life of the leased asset; (4) the present value of the minimum lease payments is at least substantially all of the fair value of the leased asset at the inception of the lease; or (5) the leased asset is such that it can be used only by the lessee without major modification. Lease A is a finance lease because the terms of the lease include a bargain purchase option. Lease C passes the economic life test, and lease D passes the recovery of investment test. Answer (D) is incorrect because Lease A contains a bargain purchase option, so it qualifies as a finance lease.

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[486] Gleim #: 4.18 -- Source: CIA 1191 IV-44 At the inception of a finance lease, how should the lessee account for guaranteed residual value?

A. B. C. D.

As part of minimum lease payments at present value. As part of minimum lease payments at future value. As part of minimum lease payments at future value of an annuity due. As not a part of the lease contract. Answer (A) is correct. The lessee records a finance lease as an asset and a liability at the inception of the lease at the fair value of the leased property (not to exceed the present value of the minimum lease payments). The lessees minimum lease payments include required payments (excluding contingent rent and costs for services and taxes to be paid by and reimbursed to the lessor) during the lease term and the amount of a bargain purchase option. If no bargain purchase option exists, the minimum lease payments equal the sum of the minimum payments payable over the lease term and any amounts guaranteed by the lessee or by a party related to the lessee. Answer (B) is incorrect because the guaranteed residual must be discounted to present value. Answer (C) is incorrect because the guaranteed residual value must be discounted to present value. Answer (D) is incorrect because a guaranteed residual value is part of the lease contract.

[487] Gleim #: 4.19 -- Source: CIA 585 IV-22 ABC entities, a manufacturer lessor, leased a machine to XYZ on January 1. The lease meets the criteria for a finance lease. Title to the asset will automatically pass to the lessee at the end of the lease term. Other details are as follows: Lease term Useful life of the asset Cost of the leased asset to the lessor Annual payment payable at the beginning of each year, beginning January 1 Implicit interest rate Present value of an annuity due of 1 discounted for 10 years at 10% Present value of 1 due in 10 years discounted at 10% 10 years 10 years 55,000 10,000 10% 6.7590 .3855

Assuming the fair value of the asset is at least equal to the present value of the minimum lease payments, the journal entry to record the inception of this lease on the lessors books at January 1 is

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A.

Leased machine Lease liability Cash

67,590 57,590 10,000 90,000 10,000 55,000 55,000 45,000 55,000 90,000 10,000 32,410 12,590 55,000 90,000 10,000 55,000 67,590 55,000 32,410

B.

Lease payments receivable Cash Cost of sales Inventory Unearned finance income--leases Sales

C.

Lease payments receivable Cash Finance income Gross profit on lease Inventory

D.

Lease payments receivable Cash Cost of sales Sales Inventory Unearned finance income--leases

Answer (A) is incorrect because it is the lessees journal entry. Answer (B) is incorrect because the sale should be recorded at the present value of the minimum lease payments, and the unearned finance income should be recorded as the difference between the gross lease payments receivable and the present value of this gross investment. Answer (C) is incorrect because the lease should reflect both cost of goods sold and sales, not the netted gross profit on the lease. Answer (D) is correct. For this finance lease, the manufacturer-lessor should record 1. As gross investment, the minimum lease payments because there is no residual value 2. As net investment, the difference between the gross investment in the lease (a debit to a receivable) and unearned finance income (a credit to a liability) 3. As unearned finance income, the difference between the gross investment and the net investment (gross investment discounted at the interest rate implicit in the lease) 4. As sales revenue, the fair value of the asset or, if lower, the present value of the minimum lease payments computed at the interest rate implicit in the lease 5. As cost of goods sold, the cost of the leased asset Because the first payment is made at the inception of the lease, the payment structure is that of an annuity due. Sales revenue is therefore equal to the 10,000 periodic payment times the present value of an annuity due of 1 discounted for 10 years at 10% (10,000 6.7590 = 67,590). Given that cash is paid at the beginning of the year, the initial 10,000 cash debit immediately decreases the gross investment in the lease (lease payments receivable) from 100,000 to 90,000. The cost of the leased asset (55,000) must also be charged to cost of sales and credited to inventory. Finally, at the inception of the lease, unearned finance income equals the difference between the gross investment and the sales price (100,000 67,590 = 32,410).

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[488] Gleim #: 4.20 -- Source: J.O. Hall On August 1, Jones leased property to Smith for a 5-year period. The annual 20,000 lease payment is payable at the end of each year. The expected residual value at the end of the lease term is 10,000. Joness implicit interest rate is 12%. The cost of the property to Jones was 50,000, which is the fair value at the lease date. The present value of an ordinary annuity of 1 for five periods is 3.605. The present value of 1 at the end of five periods is .567. At the inception of the lease, the recorded gross investment is

A. B. C. D.

110,000 100,000 72,100 90,000 Answer (A) is correct. For a finance lease, the lessor should record the gross investment in the lease at the undiscounted sum of the minimum lease payments (the total of the lessees required payments, excluding contingent rent and costs for services and taxes to be paid by and reimbursed to the lessor, and any guaranteed residual value) and any unguaranteed residual value. The gross investment is the same regardless of whether any residual value is guaranteed. The five periodic payments of 20,000 equal 100,000. The expected residual value including guaranteed and unguaranteed portions equals 10,000. The gross investment should be 110,000 (100,000 + 10,000). Answer (B) is incorrect because 100,000 does not include the residual value in the gross investment. Answer (C) is incorrect because the annual lease payments should be recorded at their undiscounted value. Answer (D) is incorrect because the residual value is added to, not subtracted from, the undiscounted lease payments.

[489] Gleim #: 4.21 -- Source: H.F. Bush KW Ltd. leased equipment under a 4-year, noncancelable lease properly classified as a finance lease. The lease does not transfer ownership or contain a bargain purchase option. The equipment had an estimated economic life of 5 years and an estimated residual value of 20,000. Terms of the lease included a guaranteed residual value of 50,000. KW initially recorded the leased equipment at 240,000, and its depreciation policy for owned assets is to use the straight-line method. Thus, the amount of depreciation that should be charged each year is

A. B. C. D.

55,000 47,500 44,000 38,000 Answer (A) is incorrect because the guaranteed residual value, not the estimated residual value, must be subtracted from the amount initially recorded. Answer (B) is correct. Depreciation should be consistent with the accounting policy for owned assets. Absent a reasonable certainty that the lessee will own the asset at the end of the lease term, it should be fully depreciated over the shorter of the useful life or the lease term. The lease does not transfer ownership or contain a bargain purchase option. Accordingly, the period of amortization should be the lease term. In accordance with the straight-line method used by KW for owned assets, the depreciable base for this finance lease is equal to the 240,000 initially recorded minus the 50,000 guaranteed residual value allocated equally over the 4-year lease term. Consequently, annual depreciation expense is 47,500 [(240,000 50,000) 4 years]. Answer (C) is incorrect because the guaranteed residual value, not the estimated residual value, must be subtracted from the initially recorded amount, and the term of the lease, not the estimated economic life, is used as the denominator in the depreciation calculation. Answer (D) is incorrect because the term of the lease, not the estimated economic life, must be used as the denominator in the depreciation calculation.

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[Fact Pattern #32]

On January 1, Plantation Partners is planning to enter as the lessee into the two lease agreements described in the opposite column. Each lease is noncancelable, and Plantation does not receive title to either leased property during or at the end of the lease term. All payments required under these agreements are due on January 1 each year.

Lessor Type of property Yearly rental Lease term Economic life Purchase option Renewal option Fair value at inception of lease Unguaranteed residual value Lessees incremental borrowing rate Executory costs paid by Annual executory costs Present value factor at 10% (of an annuity due)

Lease A Oven 15,000 10 years 15 years None None 125,000 None 10% Lessee 800 6.76

Lease B Computer 4,000 3 years 5 years 3,000 None 10,200 2,000 10% Lessor 500 2.74

[490] Gleim #: 4.22 -- Source: CMA 1293 2-27 (Refers to Fact Pattern #32) Plantation should treat Lease A as a(n)

A. B. C. D.

Finance lease with an initial asset amount of 101,400. Operating lease, charging 14,200 in rental expense and 800 in executory costs to annual operations. Operating lease, charging the present value of the yearly rental expense to annual operations. Operating lease, charging 15,000 in rental expense and 800 in executory costs to annual operations. Answer (A) is incorrect because Lease A does not qualify as a finance lease. Answer (B) is incorrect because rental expense is 15,000. Answer (C) is incorrect because the actual cash outlay for rent, 15,000, is charged to expense. Answer (D) is correct. Lease A is an operating lease with a 15,000 annual rental expense with annual executory costs (e.g., maintenance, insurance, and taxes) of 800 to be paid by the lessee. An operating lease does not transfer the risks and rewards of ownership to the lessee. Lease A is nothing more than a rental arrangement. Circumstances in which the risks and rewards of ownership are normally deemed to be transferred include the following: the lease transfers title to the lessee, the lease has a bargain purchase option, the lease term is for the major part of the useful life of the leased asset, the present value of the minimum lease payments is at least substantially all of the assets fair value, or the asset is usable only by the lessee without major modification.

[491] Gleim #: 4.23 -- Source: CMA 1293 2-28 (Refers to Fact Pattern #32) Plantation should treat Lease B as a(n)

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A. B. C. D.

Finance lease with an initial asset amount of 10,960. Finance lease with an initial asset value of 10,200. Operating lease, charging 3,500 in rental expense and 500 in executory costs to annual operations. Finance lease with an initial asset value of 9,590. Answer (A) is incorrect because the initial asset amount cannot exceed the fair value of the leased asset. Moreover, 10,960 includes the present value of the executory costs. Answer (B) is incorrect because 10,200 is the fair value of the leased asset. Answer (C) is incorrect because the lease meets the criteria of a finance lease. Answer (D) is correct. A finance lease is one in which the risks and rewards of ownership are transferred to the lessee. For accounting purposes, the lessee treats a finance lease as similar to the purchase of an asset capitalized at the fair value of the leased asset or, if lower, the present value of the minimum lease payments. The lessees minimum lease payments include the required payments, excluding contingent rent and executory costs (e.g., taxes and insurance), plus any amounts guaranteed by the lessee or a related party. If a bargain purchase option exists, however, minimum lease payments equal the required payments plus the amount of the option. If the present value of the minimum lease payments (calculated without guaranteed amounts or a bargain purchase option) is substantially all of the assets fair value, the lease normally is accounted for as a finance lease. Given that the executory costs associated with the lease are to be paid by the lessor, a portion of the lease rental price is for those costs, not for the asset. Consequently, the annual minimum lease payment equals the annual payment minus the executory costs, or 3,500 (4,000 yearly rental 500). The present value of the minimum lease payments is therefore 9,590 (2.74 3,500), which is substantially all of the fair value of the asset. Thus, the lease should be capitalized. The appropriate amount of the initial asset value is the present value of the minimum lease payments calculated above.

[492] Gleim #: 4.24 -- Source: CIA 596 IV-75 Which one of the following statements best describes the asset-liability method of accounting for deferred income taxes?

A. The amount of deferred tax is based on tax rates in effect when temporary differences originate. B. The amount of deferred tax is based on the tax rates expected to be in effect during the periods in which the deferred tax liability is settled or the deferred tax asset is realized. C. The tax effects of temporary differences are not reported separately but are reported as adjustments to the amounts of specific assets and liabilities and the related revenues and expenses. D. The appropriate tax rate to be reported on the income statement is the tax actually levied in that year, meaning no deferred taxes would be reported. Answer (A) is incorrect because this statement describes the deferred method of accounting for deferred income taxes. Answer (B) is correct. A DTA or DTL is measured at the rates expected to apply when it is realized or settled, based on tax laws and rates enacted or substantively enacted as of the balance sheet date. If different rates apply to different taxable profit levels, a DTA or DTL is measured based on the average rates expected to apply in the periods when the TDs are expected to reverse. The tax rate or tax base may vary with the manner of recovery or settlement. For example, one tax rate may apply if an asset is sold immediately and another may apply if it is to be recovered through continued use. Answer (C) is incorrect because this statement describes the net-of-tax method, which recognizes that future taxability and deductibility are important factors in the valuation of individual assets and liabilities. Answer (D) is incorrect because this statement describes the nonallocation or flow-through approach, which does not support the calculation and reporting of deferred income tax. [493] Gleim #: 4.25 -- Source: CMA 696 2-9 Which one of the following temporary differences will result in a deferred tax asset?

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A. Use of the straight-line depreciation method for determining accounting profit and an accelerated method for determining taxable profit (tax loss). B. Installment sale profits accounted for on the accrual basis for determining accounting profit and on a cash basis for determining taxable profit (tax loss). C. Advance rental receipts accounted for on the accrual basis for financial statement purposes and on a cash basis for tax purposes. D. Prepaid expenses accounted for on the accrual basis for determining accounting profit and on a cash basis for determining taxable profit (tax loss). Answer (A) is incorrect because using an accelerated depreciation method for determining taxable profit (tax loss) results in a deferred tax liability. Answer (B) is incorrect because recognizing installment income on the financial statements but not the tax return results in a taxable temporary difference. Answer (C) is correct. A deferred tax asset records the deferred tax consequences attributable to deductible temporary differences and carryforwards. Advance rental receipts accounted for on the accrual basis for determining accounting profit and on a cash basis for determining taxable profit (tax loss) would give rise to a deferred tax asset. The financial statements would show no income and no related tax expense because the rental payments apply to future periods. The tax return, however, would show the rent as income when the cash was received, and a tax would be due in the year of receipt. Because the tax is paid prior to recording accounting profits, it represents an asset that will be recognized as an expense when income is finally recorded. Answer (D) is incorrect because recognizing prepaid expenses earlier on the tax return than on the financial statements (a situation akin to the accelerated depreciation of fixed assets) gives rise to a deferred tax liability. [494] Gleim #: 4.26 -- Source: Publisher At December 31, SCM Ltd., a calendar-year entity, reported the following accounts for which the carrying amount differed from the tax base: Carrying Amount Depreciable assets (net) Deferred rental income 150,000 40,000 Tax Base 80,000 0

What taxable and deductible amounts are related to these temporary differences?

Taxable Amounts A. B. C. D. 40,000 70,000 0 110,000

Deductible Amounts 70,000 40,000 110,000 0

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Answer (A) is incorrect because the taxable amount is 70,000 and the deductible amount is 40,000. Answer (B) is correct. The difference between the carrying amount of an asset or liability and its tax base is a temporary difference (TD). A taxable (deductible) TD results in taxable (deductible) amounts in the future when the carrying amount of the asset or liability is recovered or settled. The tax base is the amount attributed for tax purposes to an asset or liability. The tax base of an asset is the amount deductible against future taxable economic benefits when the assets carrying amount is recovered. The tax base of a liability is the portion of the carrying amount that will not be deductible against future taxable economic benefits for tax purposes. The tax base of revenue received in advance (a liability) is the portion of the carrying amount taxable in the future. Thus, the 70,000 temporary difference (150,000 carrying amount 80,000 tax base) related to the depreciable assets is classified as a taxable amount. When income, such as rental income, is taxable before being recognized in accounting profit, future sacrifices to provide the rental service or refund amounts paid will result in future tax deductible amounts when the liability is settled. Thus, the 40,000 temporary difference (40,000 carrying amount 0 tax base) related to the deferred rental revenue is classified as a deductible amount. Answer (C) is incorrect because the taxable amount is 70,000 and the deductible amount is 40,000. Answer (D) is incorrect because the taxable amount is 70,000 and the deductible amount is 40,000. [495] Gleim #: 4.27 -- Source: Publisher Which of the following results in a tax base of zero?

A. Trade receivables have a carrying amount of 1,000, and the related revenue has been included in full in the determination of taxable profit. B. A loan receivable has a carrying amount of 1,000, and repayment has no tax effects. C. Unearned interest revenue has a carrying amount of 1,000, and the related interest revenue was included in full in the determination of taxable profit. D. Accrued expenses have a carrying amount of 1,000, and the related expense has been included in full in the determination of taxable profit. Answer (A) is incorrect because the tax base is 1,000. Answer (B) is incorrect because the tax base is 1,000. Answer (C) is correct. The difference between the carrying amount of an asset or liability and its tax base is a temporary difference (TD). A taxable (deductible) TD results in taxable (deductible) amounts in the future when the carrying amount of the asset or liability is recovered or settled. The tax base is the amount attributed for tax purposes to an asset or liability. The tax base of an asset is the amount deductible against future taxable economic benefits when the assets carrying amount is recovered. The tax base of a liability is the portion of the carrying amount that will not be deductible against future taxable economic benefits for tax purposes. The tax base of revenue received in advance (a liability) is the portion of the carrying amount taxable in the future. For unearned interest revenue for which the related interest revenue was taxed on a cash basis, the tax base equals zero (1,000 carrying amount 1,000 not taxable in the future). Answer (D) is incorrect because the tax base is 1,000. [Fact Pattern #33] An entity has purchased an asset with a 10-year useful life. It will use an accelerated depreciation method for determining taxable profit or tax loss. For determining accounting profit, it will use straight-line depreciation. [496] Gleim #: 4.28 -- Source: CIA 1194 IV-69 (Refers to Fact Pattern #33) During the 10-year life of the asset, the entity will report as deferred tax an amount that

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A. B. C. D.

Increases steadily for the 10 years. Is constant. Increases and then decreases. Decreases and then increases. Answer (A) is incorrect because the deferred tax liability will increase and then decrease. Answer (B) is incorrect because the deferred tax liability will increase and then decrease. Answer (C) is correct. The cumulative deferred tax increases, peaks, and then decreases to zero over the life of the asset. In the early years, the asset is depreciated more quickly for tax purposes than for financial reporting purposes. This temporary difference reverses in later years. Hence, in the early years, actual taxes payable will be less than tax expense reported in the financial statements, and a deferred tax liability will be recognized. By the end of the assets useful life, cumulative actual taxes paid will equal cumulative reported tax expense, so the deferred tax balance will be zero. Answer (D) is incorrect because the deferred tax liability will increase and then decrease.

[497] Gleim #: 4.29 -- Source: CIA 1194 IV-70 (Refers to Fact Pattern #33) When determining cash flows accruing to the entity, using financial statements prepared for tax purposes will result in

A. B. C. D.

No effect on cash flow amounts. An overstatement of cash flows throughout the economic life of the asset. An understatement of cash flows throughout the economic life of the asset. An overstatement of cash flows in the early years and then an understatement of cash flows in the later years of the economic life of the asset. Answer (A) is correct. Cash flows are not affected by the basis of accounting used to prepare the financial statements. Accordingly, whether the financial statements are prepared based on the tax basis, the cash basis, or accounting principles generally accepted in a given country, cash flows should be the same. For example, the cash inflow or outflow resulting from using an accelerated depreciation method to determine actual tax expense or benefit (the amount paid to or refunded by the taxing authority) is completely unaffected by the depreciation method used in the financial statements. However, if cash flows are derived indirectly by adjusting net profit or loss reported in the financial statements, different adjustments are necessary to arrive at the same cash flow amounts if different bases of accounting are used in the preparation of the financial statements. Answer (B) is incorrect because cash flows are not affected by the method of depreciation used for reporting purposes. Answer (C) is incorrect because cash flows are not affected by the method of depreciation used for reporting purposes. Answer (D) is incorrect because cash flows are not affected by the method of depreciation used for reporting purposes.

[498] Gleim #: 4.30 -- Source: Publisher Based on its current operating levels, Glucose LLC estimates that its annual level of taxable profit in the foreseeable future will be 200,000 annually. Enacted tax rates for the tax jurisdiction in which Glucose operates are 15% for the first 50,000 of taxable profit, 25% for the next 50,000 of taxable profit, and 35% for taxable profit in excess of 100,000. Which tax rate should Glucose use to measure a deferred tax liability or asset?

A. B. C. D.

15% 25% 27.5% 35%

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Answer (A) is incorrect because 15% is the tax rate for the first 50,000 of taxable profit. Answer (B) is incorrect because 25% is the tax rate for taxable profit over 50,000 but less than 100,000. Answer (C) is correct. In measuring a deferred tax liability or asset, the objective is to use the enacted or substantively enacted tax rate(s) expected to apply to taxable profit in the periods in which the deferred tax liability or asset is expected to be settled or realized. If different rates apply to different taxable profit levels, a DTA or DTL is measured based on the average rates expected to apply in the periods when the TDs are expected to reverse. Accordingly, the applicable tax rate is 27.5%.

Taxable Profit 50,000 50,000 100,000 200,000

Tax Rate 15% 25% 35% = = = 7,500 12,500 35,000 55,000

55,000 200,000 = 27.5% Answer (D) is incorrect because 35% is the tax rate for taxable profit over 100,000. [499] Gleim #: 4.31 -- Source: Publisher When an entity reports deferred tax assets and liabilities, deferred tax expense or income should be disclosed equal to the

A. B. C. D.

Decrease in the deferred tax assets. Sum of the net changes in deferred tax assets and deferred tax liabilities. Increase in the deferred tax liabilities. Amount of the total tax liability. Answer (A) is incorrect because the deferred tax expense or income is equal to the sum of the net changes in the deferred tax assets and deferred tax liabilities. Answer (B) is correct. The deferred tax expense or income disclosed is the sum of the net changes in the deferred tax assets and deferred tax liabilities. This amount is the deferred tax expense or income relating to the origination or reversal of temporary differences. For example, the reduction in a deferred tax asset or an increase in a deferred tax liability increases deferred tax expense. Answer (C) is incorrect because the deferred tax expense or income is equal to the sum of the net changes in the deferred tax assets and deferred tax liabilities. Answer (D) is incorrect because the total tax liability includes both the current and deferred tax expense or income for the year.

[500] Gleim #: 4.32 -- Source: Publisher On December 31, year 1, Health entities reported a 150,000 warranty expense in its income statement. The expense was based on actual warranty costs of 30,000 in year 1 and expected warranty costs of 35,000 in year 2, 40,000 in year 3, and 45,000 in year 4. For tax purposes, warranty costs are not deductible until paid. At December 31, year 1, deferred taxes should be based on a

A. B. C. D.

120,000 deductible temporary difference. 150,000 deductible temporary difference. 120,000 taxable temporary difference. 150,000 taxable temporary difference.

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Answer (A) is correct. At year-end year 1, Health entities should report a 120,000 warranty liability in its balance sheet. The warranty liability is equal to the 150,000 warranty expense minus the 30,000 warranty cost actually incurred in year 1. Because warranty costs are not deductible until paid, the tax base of the warranty liability is 0. The result is a 120,000 temporary difference (120,000 carrying amount 0 tax base). When the liability is settled through the actual incurrence of warranty costs, the amounts will be deductible. Thus, the temporary difference should be classified as a deductible temporary difference. Answer (B) is incorrect because 150,000 equals the warranty expense, not the payable. Answer (C) is incorrect because warranty costs will result in a deductible amount. Answer (D) is incorrect because the warranty costs will result in a deductible amount, and the 30,000 actual warranty costs is currently deductible. [501] Gleim #: 4.33 -- Source: CIA 597 IV-29 An entity introduced a new product that carries a 2-year warranty against defects. It estimates that warranty costs will be 2% of sales in the year of sale and 3% of sales in the year following the year of sale. Sales in year 1 and year 2 were 5 million and 7 million, respectively. Actual costs of servicing the warranty in year 1 and year 2 were 110,000 and 260,000, respectively. What provision for warranty costs must the entity recognize in year 2?

A. B. C. D.

260,000 290,000 350,000 370,000 Answer (A) is incorrect because 260,000 is the actual cost of servicing the warranty in year 2. Answer (B) is incorrect because 290,000 equals the sum of 2% of year 2 sales and 3% of year 1 sales. Answer (C) is correct. The warranty provision must be matched with revenue in the year of sale. Thus, the provision related to year 2 sales must be recognized in year 2 even if actual expenditures will not occur until year 3. The provision related to year 2 sales equals 350,000 [7,000,000 (2% for the year of sale + 3% for the year after the year of sale)]. Answer (D) is incorrect because 370,000 equals the actual cost of servicing the warranty in year 1 and year 2.

[502] Gleim #: 4.34 -- Source: CIA 590 IV-34 On December 31, 2000, XYZ issued 5-year bonds with a face amount of 1 million. The bonds carry a stated interest rate of 10% and were sold at par. Interest is payable annually on December 31. According to the provisions of the bond indenture, XYZ was to make annual deposits into a bond sinking fund (beginning December 31, 2001) to accumulate the funds necessary to retire the bonds at their maturity. On December 31, 2004, all required interest payments and sinking-fund payments due to date had been made on schedule. If the sinking-fund assets are properly classified as noncurrent, how should the balance of bonds payable be classified on the December 31, 2004 balance sheet?

A. B. C. D.

Current liability. Long-term liability. Contra to long-term investments. Deferred credit.

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Answer (A) is correct. A current liability is an obligation that is expected to be settled within the normal operating cycle or is due to be settled within 12 months of the balance sheet date. Any other liability is noncurrent. Some current liabilities are included in the working capital employed in the normal operating cycle, e.g., trade payables and accrued employee operating costs. Current liabilities not settled within the normal operating cycle include the current part of interest-bearing debt, dividends, income taxes, and bank overdrafts. Thus, the bonds payable should be classified as current because they are due to be settled within 12 months. Under the IASs, the classification of the sinking-fund assets is irrelevant to the classification of the bond payable. Answer (B) is incorrect because the bonds should be classified as a current liability. Answer (C) is incorrect because offsetting assets and liabilities is rarely acceptable. Answer (D) is incorrect because the bonds are a liability and should not be put in an ambiguous category such as deferred credits. [503] Gleim #: 4.35 -- Source: CIA 1192 IV-31 On August 1, 2000, an entity issued 5-year bonds with a face amount of 10 million. The bonds carry a stated interest rate of 10% and interest is payable annually on July 31. Which is the appropriate classification of bonds payable and the related accrued interest payable on the December 31, 2004 balance sheet? Classification Table Bonds Payable Classification A Classification B Classification C Classification D Current liability Current liability Long-term liability Long-term liability Interest Payable Current liability Long-term liability Current liability Long-term liability

A. B. C. D.

Classification A. Classification B. Classification C. Classification D. Answer (A) is correct. A current liability is an obligation that is expected to be settled within the normal operating cycle or is due to be settled within 12 months of the balance sheet date. Any other liability is noncurrent. Some current liabilities are included in the working capital employed in the normal operation cycle, e.g., trade payables and accrued employee operating costs. Current liabilities not settled within the normal operating cycle include the current part of interest-bearing debt, dividends, income taxes, and bank overdrafts. Given that the bonds payable and interest payable are due within 12 months, they should be classified and current. Answer (B) is incorrect because the interest payable should be classified as a current liability. It is due within a year after the balance sheet date. Answer (C) is incorrect because the balance of bonds payable should be classified as a current liability. The bonds are due within a year after the balance sheet date. Answer (D) is incorrect because both the balance of bonds payable and interest payable should be classified as current liabilities.

[504] Gleim #: 4.36 -- Source: CIA 1193 IV-39 A manufacturer produces a quality product for which it charges a little more than some competing items but gives its consumers a more liberal warranty policy. The product carries a 5-year warranty that covers both labor and materials charges. Which of the following defines the appropriate method of accounting for the warranty?

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A. B. C. D.

Cash basis. Recognition of a provision. Sales warranty. Tax basis. Answer (A) is incorrect because the cash basis calls for recognizing warranty expense as labor and materials are expended to satisfy the warranty. Answer (B) is correct. A provision is a liability of uncertain timing and amount. A liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. Whether a past event results in a present obligation is usually clear. Thus, it is clear from the circumstances that the entitys sale of goods without warranty is an obligating event that resulted in a present obligation for the issuance of warranty costs. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated. Assuming that the amount of warranty costs can be reliably estimated (although they are uncertain in timing and amount compared with a trade payable, for example) and that the outflow is probable (in these circumstances, more likely than not), the manufacturers contractual present obligation should result in recognition of a provision. Answer (C) is incorrect because the sales warranty method is appropriate for situations when a warranty is sold separately from the product. Answer (D) is incorrect because the method of accounting for warranties for tax purposes is the cash basis. The cash basis is unacceptable for accounting purposes because it violates the matching principle.

[505] Gleim #: 4.37 -- Source: CIA 1191 IV-41 At its balance sheet date, an entity reliably estimates that the expected cost of compensated absences resulting from short-term disability will be 100,000. This unused entitlement arose from employee services rendered during the period and is accumulating. How should it be accounted for?

A. B. C. D.

Only a disclosure should be made because recognition does not occur until the absences occur. An expense should be recorded for 100,000. An asset of 100,000 should be recognized. A direct reduction to retained earnings of 100,000 should occur. Answer (A) is incorrect because recognition occurs at the time of the absences if the benefits are not accumulating. Answer (B) is correct. Short-term employee benefits expected to be paid as a result of service rendered during the period ordinarily should be recognized as an expense and a liability (accrued expense). For short-term compensated absences, the timing of recognition depends on whether the benefits accumulate. If the benefits for compensated absences accumulate, the expected cost of short-term compensated absences is recognized when services are rendered that increase the employees entitlement to future compensated absences. The obligation is recognized whether it is vesting (the employee is entitled to a cash payment for an unused entitlement upon leaving the entity) or not vesting. The amount should not be discounted. It equals the additional amount expected to be paid as a result of the unused accumulated entitlement at the balance sheet date. Hence, the entity should debit expense and credit liability for 100,000 because the entitlement accumulates and the employees have rendered services during the period that increase their future entitlement. Answer (C) is incorrect because a liability rather than an asset is recognized. Answer (D) is incorrect because the expense is recognized in the income statement.

[506] Gleim #: 4.38 -- Source: CIA 1190 IV-37 A company allows customers to redeem 20 coupons for a toy (cost 3.00). Estimates are that 40% of coupons distributed will result in redemption. Since beginning the promotion this year, 4 million coupons were distributed and 1 million coupons redeemed. The adjusting entry to accrue for unredeemed coupons at year-end is

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A. Premium expense Provision for premiums B. Sales Provision for premiums C. Premium expense Provision for premiums D. Sales Provision for premiums

90,000 90,000 90,000 90,000 1,800,000 1,800,000 1,800,000 1,800,000

Answer (A) is correct. An expense and a provision should be accrued for the coupons still outstanding that are expected to be redeemed. Of the 4 million coupons distributed, 40%, or 1.6 million, are estimated to be redeemable. Of those, 1 million have already been redeemed, and 600,000 more are expected to be redeemed. The promotion requires 20 coupons to receive one toy, so 30,000 (600,000 20) more toys will be required. Each toy costs 3.00, creating a provision of 90,000 (30,000 3.00). Answer (B) is incorrect because the debit should be to an expense. Answer (C) is incorrect because, although an expense should be accrued, the amount is incorrect. Answer (D) is incorrect because the debit should be to an expense, and the amount is incorrect. [507] Gleim #: 4.39 -- Source: CIA 1192 IV-29 The publisher of a popular magazine offers a special discounted price for a 3-year subscription. At the balance sheet date, the amount that has already been collected but pertains to future periods is best referred to as

A. B. C. D.

Accrued subscriptions revenue (an asset account). Deferred subscriptions revenue (a liability account). Earned subscriptions revenue (a revenue account). Precollected subscriptions receivable (a deferred asset account). Answer (A) is incorrect because an accrued revenue is revenue that has met the recognition criteria but has not been received. Answer (B) is correct. Income, which includes revenue and gains, is recognized in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease in a liability can be reliably measured. Revenue is recognized (reported as revenue) in the period in which the recognition criteria are met; therefore, when it is received in advance, the amount applicable to future periods is deferred. This deferral reflects the uncertainty of the reliable measurement of the future economic benefits. The uncertainty arises because the entity still must satisfy an obligation to perform in the future before it is entitled to the future economic benefits. The amount received in advance is considered a liability because it represents a present obligation arising from a past event. Accordingly, deferred or unearned revenue is an amount that has been received but that has not met the recognition criteria for revenue. Answer (C) is incorrect because the revenue will be recognized in future periods when forthcoming issues of the magazine are published and distributed to the subscribers. Answer (D) is incorrect because there is no such thing as a precollected receivable. Precollected revenue is deferred revenue, which is an amount received that has not met the recognition criteria (classified as a liability). A subscription receivable (an asset) would arise from accrued revenue, which is revenue not yet received.

[508] Gleim #: 4.40 -- Source: CIA 592 IV-38 A cable television entity receives deposits from customers that are refunded when service is terminated. The average customer stays with the entity 8 years. How should these deposits be shown on the financial statements?

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A. B. C. D.

Operating revenue. Other revenue. Share capital. Liability. Answer (A) is incorrect because deposits meet the definition of liabilities, not revenue. Revenue is income that arises in the ordinary activities of the entity. Income is an increase in economic benefits in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity (excluding transactions with owners). Answer (B) is incorrect because deposits meet the definition of liabilities, not revenue. Revenue is income that arises in the ordinary activities of the entity. Income is an increase in economic benefits in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity (excluding transactions with owners). Answer (C) is incorrect because deposits are liabilities, not equity items. The equity of an entity is the residual interest in the assets of an entity that remains after deducting its liabilities. Answer (D) is correct. Liabilities are present obligations arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits. Customers deposits must be returned or credited to their accounts. The deposits should therefore be recorded as liabilities.

[509] Gleim #: 4.41 -- Source: CIA 590 IV-28 In performing an audit, you encounter an adjusting journal entry recorded at year-end that contains a debit to rental revenue and a credit to deferred rental revenue. The purpose of this journal entry is to record

A. B. C. D.

An accrued revenue. An unexpired expense. An expired expense. A liability. Answer (A) is incorrect because an accrued revenue has met the recognition criteria but has not yet been received. The journal entry described indicates that collection has been made. Answer (B) is incorrect because the entry concerns a revenue rather than an expense transaction. Answer (C) is incorrect because the entry concerns a revenue rather than an expense transaction. Answer (D) is correct. A deferred revenue is a revenue item that has been received but has not met the recognition criteria. The journal entry described in the question is an adjusting entry to transfer an amount from the revenue account to a liability (deferred revenue) account. The initial collection of cash in advance from the tenant was apparently recorded by a credit to revenue. An adjusting entry is therefore required at year-end to transfer any remaining amount that does not qualify for revenue recognition.

[510] Gleim #: 4.42 -- Source: CIA 597 IV-36 Because of a defect discovered in its seat belts in December 2004, an automobile manufacturer believes it is probable that it will be required to recall its products. The final decision on the recall is expected to be made in March 2005. The cost of the recall is reliably estimated to be 2.5 million. How should this information be reported in the December 31, 2004 financial statements?

A. B. C. D.

As a loss of 2.5 million and a provision of 2.5 million. As an adjustment of the opening balance of retained earnings equal to 2.5 million. As an appropriation of retained earnings of 2.5 million. It should not be disclosed because it has not yet happened.

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Answer (A) is correct. A provision is a liability of uncertain timing or amount. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated. Consequently, the company must recognize a loss and a liability for 2.5 million. Answer (B) is incorrect because such an adjustment is appropriate for fundamental errors and changes in accounting policies (under the benchmark treatments). Answer (C) is incorrect because an appropriation of retained earnings is permissible although not required, but the entity must still recognize a loss and a provision. Moreover, no part of the appropriation may be transferred to income, and no loss may be charged to an appropriation of retained earnings. Answer (D) is incorrect because, if the loss is probable and can be reliably estimated, it should be recognized by a charge to income. [511] Gleim #: 4.43 -- Source: CIA 1192 IV-45 An entity is subject to warranty claims. A reliable estimate is that between 1 million and 3 million will probably be paid out. No estimate of loss within this range is more likely than any other. The entity should

A. B. C. D.

Make no journal entry at this time. Disclose only a possible loss. Defer a provision of 1 million to 3 million depending on the applicable national accounting standards. Recognize a provision of 1 million to 3 million depending on the applicable national accounting standards. Answer (A) is incorrect because the criteria for recognition of a provision have been met, including a reliable estimate of the range of the obligation. Answer (B) is incorrect because the loss is probable. Answer (C) is incorrect because the loss is not deferred; it is accrued. Answer (D) is correct. A provision is a liability of uncertain timing or amount. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated. Thus, a provision should be recognized. Moreover, the amount recognized should be the best estimate of the expenditure required to settle the obligation. However, the amount within the reliable estimate of the range of the obligation that will be recognized will vary from country to country.

[512] Gleim #: 4.44 -- Source: CIA 596 IV-25 Which one of the following will usually be accounted for by recognizing a provision?

A. Just prior to the balance sheet date, the board decided to close a division. No implementation steps have been taken. B. As of the balance sheet date, the board was aware that a new law would require the entity to fit smoke filters to its factories within the next year. No such filters have been fitted. C. A law requires an airline to overhaul its aircraft once every 3 years. D. Premiums offered to customers.

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Answer (A) is incorrect because no obligating event has occurred. The entity could avoid the future expenditure by its future actions. Answer (B) is incorrect because no obligating event has occurred. The entity could avoid the future expenditure by its future actions. Answer (C) is incorrect because no obligating event has occurred. The entity could avoid the future expenditure by its future actions. Answer (D) is correct. When premiums are offered to customers, for example, upon redemption of coupons, the entity can usually establish that it has a legal present obligation resulting from a past event and that an outflow of economic benefits is probable. Furthermore, if the entity has prior experience with such offers or information about the experience of similar entities, a reliable estimate of the obligation should be feasible. [513] Gleim #: 4.45 -- Source: CIA 595 IV-20 Which of the following is not a factor, with respect to pending litigation, that must be considered in determining whether a provision should be recognized?

A. B. C. D.

The time period in which the underlying cause of action occurred. The probability of an unfavorable outcome. The ability to make a reliable estimate of the amount of loss. The number of parties involved in the litigation. Answer (A) is incorrect because the time period in which the obligating event occurred is relevant. If it arose after the date of the financial statements, a provision may not be recognized in those statements. Answer (B) is incorrect because a provision is not recognized unless it is probable that an outflow of resources embodying economic benefits will be required to settle a present obligation arising from a past event. Answer (C) is incorrect because a provision is not recognized unless it is probable that an outflow of resources embodying economic benefits will be required to settle a present obligation arising from a past event. Moreover, the amount of the obligation should be capable of reliable estimation. Answer (D) is correct. The number of parties involved in the litigation is irrelevant. For example, the same accounting treatment is applied whether a claim is brought by an individual or in a class action suit.

[514] Gleim #: 4.46 -- Source: CIA 589 IV-33 An entity has been sued for 100 million for producing and selling an unsafe product. Attorneys for the entity cannot reliably predict the outcome of the litigation. In its financial statements, the entity should

A. Make the following journal entry, and disclose the existence of the lawsuit in a footnote. Estimated loss from litigation 100,000,000 Estimated provision for litigation loss 100,000,000 B. Disclose the existence of the lawsuit in a note without making a journal entry. C. Neither make a journal entry nor disclose the lawsuits in a note because bad publicity will hurt the entity. D. Make the following journal entry, and disclose the existence of the lawsuit in a note. Cost of goods sold 100,000,000 Estimated provision for litigation loss 100,000,000

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Answer (A) is incorrect because a journal entry is made when the outflow in settlement is probable and can be reliably estimated. Answer (B) is correct. In the very rare case in which a reliable estimate of an obligation that otherwise qualifies for treatment as a provision cannot be determined, no liability is recognized. Instead, the existing liability is disclosed as a contingent liability (unless the possibility of any outflow in settlement is remote). Answer (C) is incorrect because a disclosure must be made of a contingent liability. Answer (D) is incorrect because a journal entry is made when the outflow in settlement is probable and can be reliably estimated. [515] Gleim #: 4.47 -- Source: Publisher An entity is currently being sued by a customer. A reliable estimate can be made of the costs that would result from a ruling unfavorable to the entity, and the amount involved is material. The entitys managers, lawyers, and auditors agree that the likelihood of an unfavorable ruling is remote. This contingent liability

A. B. C. D.

Should be disclosed in a note. Should be disclosed as a parenthetical comment in the balance sheet. Need not be disclosed. Should be disclosed by an appropriation of retained earnings. Answer (A) is incorrect because the contingent liability is required to be neither recognized nor disclosed. Answer (B) is incorrect because the contingent liability is required to be neither recognized nor disclosed. Answer (C) is correct. A contingent liability includes a present obligation for which an outflow of resources embodying economic benefits is not probable. A contingent liability is not recognized but is disclosed unless the possibility of the outflow is remote. Answer (D) is incorrect because the contingent liability is required to be neither recognized nor disclosed.

[516] Gleim #: 4.48 -- Source: CIA 597 IV-19 In November of the current year, the vice-president of a local bank reviews the banks mortgage portfolio prior to the December 31 year-end. The banks largest client has mortgages on buildings in three cities. The client has incurred net losses for the past 3 years and is now experiencing serious cash flow problems. For the past 6 months, no payments have been made on any of the three mortgages. The vice-president reluctantly concludes that it is probable that the full amount of principal and interest will not be collected. What is the impact of this conclusion on the local banks current year financial statements?

A. B. C. D.

No accounting or disclosure of a possible loss in value is necessary. Contingency note disclosure of a possible impairment is required. The carrying amount of the mortgages should be reduced, with a charge directly to retained earnings. The carrying amount of the mortgages should be reduced, with a charge to the income statement.

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Answer (A) is incorrect because the carrying amount should be reduced, and the charge should be included in net profit or loss. Answer (B) is incorrect because the carrying amount should be reduced, and the charge should be included in net profit or loss. Answer (C) is incorrect because the carrying amount should be reduced, and the charge should be included in net profit or loss. Answer (D) is correct. A financial asset, such as a lenders mortgage receivable, is impaired if its carrying amount at the balance sheet date exceeds its estimated recoverable amount. If it is probable that all amounts due on such a held-to-maturity investment (a financial asset carried at amortized cost) cannot be collected, the loss should be included in net profit or loss. The loss equals the difference between the carrying amount and the present value of the expected future cash flows discounted at the original effective interest rate. The carrying amount of the asset should be reduced to its estimated recoverable amount directly or by crediting an allowance account. [517] Gleim #: 4.49 -- Source: CIA 597 IV-30 If bonds are initially sold at a discount and the effective-interest method of amortization is used,

A. B. C. D.

Interest expense in the earlier periods will be less than interest expense in the later periods. Interest expense in the earlier periods will be greater than interest expense in the later periods. Interest expense will equal the cash interest payment each period. Interest expense will be less than the cash interest payment each period. Answer (A) is correct. Interest expense equals the carrying amount of the liability at the beginning of the period times the effective interest rate. The carrying amount of the liability equals the face amount of the bond minus the discount. As the discount is amortized over the life of the bond, the carrying amount increases. Consequently, the interest expense increases over the term of the bond. Answer (B) is incorrect because interest expense will increase over the term of the bonds. Answer (C) is incorrect because interest expense exceeds the cash interest payment when bonds are issued at a discount. The reason is that the effective rate is higher than the nominal rate. The excess of interest expense over the cash payment is the amount of discount amortized each period. Answer (D) is incorrect because interest expense exceeds the cash interest payment when bonds are issued at a discount. The reason is that the effective rate is higher than the nominal rate. The excess of interest expense over the cash payment is the amount of discount amortized each period.

[518] Gleim #: 4.50 -- Source: CIA 595 IV-19 An entity issues 10-year bonds with a face value of 1 million, dated January 1, 2004 and bearing interest at an annual rate of 12% payable semiannually on January 1 and July 1. The full interest amount will be paid each due date. The market rate of interest on bonds of similar risk and maturity, with the same schedule of interest payments, is also 12%. If the bonds are issued on February 1, 2004, the amount the issuing entity receives from the buyers of the bonds on that date is

A. B. C. D.

990,000 1,000,000 1,010,000 1,020,000

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Answer (A) is incorrect because 990,000 is the result if 1 month of accrued interest is deducted from, rather than added to, the amount received. Answer (B) is incorrect because the purchasers must pay for the accrued interest from the last interest date to the issue date. They will receive 6 months interest on July 1 despite holding the bonds for 5 months. Answer (C) is correct. The amount the issuing entity receives on 2/1/04 is the face amount of the issue plus 1 month of accrued interest, or 1,010,000 {1,000,000 + [(1,000,000 12%) 12]}. Answer (D) is incorrect because 1,020,000 results from adding 2 months of accrued interest to the face amount. [519] Gleim #: 4.51 -- Source: CIA 1191 IV-39 If bonds payable with a carrying amount equal to par value are refunded by use of a call provision, the call premium of the refunded issue should be

A. B. C. D.

Amortized over the remaining original life of the extinguished issue. Amortized over the life of the new issue. Recognized currently in net profit or loss as an extraordinary item. Recognized currently in net profit or loss. Answer (A) is incorrect because the excess of the reacquisition price over the net carrying amount of the old bonds is recognized in full in net profit or loss for the period. Answer (B) is incorrect because the excess of the reacquisition price over the net carrying amount of the old bonds is recognized in full in net profit or loss for the period. Answer (C) is incorrect because an extraordinary item is income or an expense arising from events or transactions that are clearly distinct from the ordinary activities of the entity and are not expected to recur frequently or regularly. Answer (D) is correct. An entity should remove a financial liability from its balance sheet only when it is extinguished, for example, when the creditor is paid. The difference between the carrying amount and the amount paid should be included in net profit or loss for the period.

[520] Gleim #: 4.52 -- Source: CIA 591 IV-36 At December 31, 20X3, an entity had the following obligations that were expected to be refinanced:

17% note payable 15% note payable

140,000 200,000

The 17% note payable was issued on October 1, 20X2 and matures on July 1, 20X4. The 15% note payable was issued on May 1, 20X2 and matures on May 1, 20X4. On February 1, 20X4, the entire 140,000 balance of the 17% note payable was refinanced by issuance of a long-term debt instrument. On February 7, 20X4, the entity entered into a noncancelable agreement with a lender to refinance the 15% note payable on a long-term basis. The financial statements were authorized to be issued on March 1, 20X4. The total amount of obligations that may be properly excluded from current liabilities on the entitys December 31, 20X3 balance sheet is

A. B. C. D.

0 140,000 200,000 340,000

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Answer (A) is incorrect because 340,000 may be excluded from current liabilities. Answer (B) is incorrect because the 15% note is also excluded from current liabilities. Answer (C) is incorrect because the 17% note is also excluded from current liabilities. Answer (D) is correct. Some noncurrent, interest-bearing liabilities due to be settled within 12 months should nevertheless continue to be classified as noncurrent if the original term exceeded 12 months, the entity intends to refinance on a long-term basis, and its intent is supported by an agreement to refinance or reschedule payments. This agreement must be consummated before the financial statements are authorized for issue. Thus, 340,000 (140,000 + 200,000) may be excluded from current liabilities. [521] Gleim #: 4.53 -- Source: Publisher An entity most likely may derecognize a financial liability if it

A. B. C. D.

Transfers amounts to a trust to be used to repay the obligation. Exchanges debt instruments with the lender with substantially similar terms. Exchanges debt instruments with the lender with substantially different terms. Transfers amounts in a transaction that meets the requirements of an in-substance defeasance. Answer (A) is incorrect because payment to a third party such as a trust (also known as an in-substance defeasance) does not by itself extinguish the obligation absent a legal release. Answer (B) is incorrect because the terms should be substantially different. Answer (C) is correct. Derecognition of a financial liability (or a part thereof) occurs only by means of extinguishment. This condition is satisfied only when the debtor pays the creditor or is legally released from primary responsibility either by the creditor or through the legal process. An extinguishment and derecognition of the old debt and recognition of new debt occurs when the borrower and lender exchange debt instruments with substantially different terms, that is, when the respective discounted cash flows differ by at least 10%. Answer (D) is incorrect because payment to a third party such as a trust (also known as an in-substance defeasance) does not by itself extinguish the obligation absent a legal release.

[522] Gleim #: 4.54 -- Source: CIA 1192 IV-44 An entity has a 100,000 liability on the books. In 12 months, 110,000 will be due, including 10% interest. The entity negotiates settlement of the debt today by exchanging customer receivables with a carrying amount of 90,000. What is the journal entry today?

A. Liability Receivables Gain B. Liability Receivables Gain C. Liability Receivables Gain D. Liability Receivables Gain

110,000 99,000 11,000 100,000 99,000 1,000 110,000 90,000 20,000 100,000 90,000 10,000

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Answer (A) is incorrect because the liability and receivables should not be increased by the 10% interest rate. Answer (B) is incorrect because the receivables should not be increased by the 10% interest rate. Answer (C) is incorrect because the liability should not be increased by the 10% interest rate. Answer (D) is correct. An entity may derecognize a financial liability when it is extinguished. This condition is met when the debtor discharges the debt by paying the creditor, such as with cash, other financial assets (e.g., receivables), goods, or services. Consequently, the liability should be debited for its 100,000 balance. Receivables with a 90,000 balance are given up, so that account should be credited. The difference is a gain. [523] Gleim #: 4.55 -- Source: CIA 1196 IV-19 How will profit or loss be affected by the amortization of a premium on bonds payable?

A. B. C. D.

Interest expense is decreased, so net profit or loss is increased. Interest expense is increased, so net profit or loss is decreased. Interest income is increased, so net profit or loss is increased. Interest income is decreased, so net profit or loss is decreased. Answer (A) is correct. The entry is to debit interest expense, debit bond premium, and credit cash paid. Thus, the amortization of a premium on bonds payable reduces the interest expense, thereby increasing profit or loss. Answer (B) is incorrect because the amortization of a premium on bonds payable reduces interest expense. Answer (C) is incorrect because interest income is not affected by the amortization of a premium on bonds payable. Answer (D) is incorrect because interest income is not affected by the amortization of a premium on bonds payable.

[524] Gleim #: 4.56 -- Source: Publisher What is the preferred method of handling unamortized discount, unamortized issue costs, and the costs of implementing a conversion of debt into common shares?

A. B. C. D.

Expense them in the period bonds are converted. Amortize them over the remaining life of the issue retired. Amortize them over a period not to exceed 40 years. Charge them to share premium in excess of the par value of the shares issued. Answer (A) is incorrect because this amount is not expensed. In effect, it reduces the amount at which the shares are issued. Answer (B) is incorrect because this amount is not expensed. In effect, it reduces the amount at which the shares are issued. Answer (C) is incorrect because this amount is not expensed. In effect, it reduces the amount at which the shares are issued. Answer (D) is correct. The conversion of debt into common shares is ordinarily based upon the carrying amount of the debt at the time of issuance. Because the carrying amount is based on all related accounts, the debit balances of unamortized bond discount, unamortized issue costs, and conversion costs should be considered reductions in the net carrying amount at the time of conversion. Consequently, these items should be reflected as reductions in the share premium in excess of par account.

[525] Gleim #: 4.57 -- Source: CIA 1186 IV-30 On May 1, 20X4, an entity issued, at 103 plus accrued interest, 500 of its 12%, 1,000 bonds. The bonds are dated January 1, 20X4 and mature on January 1, 20X9. Interest is payable semiannually on January 1 and July 1. The journal entry to record the issuance of the bonds and the receipt of the cash proceeds is

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A. Cash Interest payable Bonds payable Premium on bonds payable B. Cash Bonds payable Premium on bonds payable Interest payable C. Cash Bonds payable Premium on bonds payable Interest payable D. Cash Bonds payable Premium on bonds payable

515,000 20,000 500,000 35,000 525,000 500,000 15,000 10,000 535,000 500,000 15,000 20,000 535,000 500,000 35,000

Answer (A) is incorrect because the bond premium is 15,000 (500,000 .03), and interest payable should be credited. Answer (B) is incorrect because interest payable should be 20,000 [500,000 .12 (4 12)]. Answer (C) is correct. The face amount of the 500 bonds is equal to 500,000 (500 1,000). The cash proceeds excluding interest from the issuance of the bonds are 515,000 (103% 500,000). The 15,000 premium is the difference between the cash issuance proceeds and the face amount of the bonds. Because the bonds were issued between interest payment dates, the issuer is also entitled to receive accrued interest for the 4 months between the prior interest date and the issuance date. The accrued interest is 20,000 [500 bonds 1,000 face value 12% stated rate (4 12)]. The issuing company will therefore receive 535,000 in cash (515,000 + 20,000). The resulting journal entry includes a 535,000 debit to cash, a 500,000 credit to bonds payable, a 15,000 credit to premium, and a 20,000 credit to either interest payable or interest expense. Answer (D) is incorrect because the premium on bonds payable should not include interest payable. [526] Gleim #: 4.58 -- Source: Publisher Debtor owes Bank on a 10-year, 15% note in the amount of 100,000, plus 30,000 accrued interest. Because of financial difficulty, Debtor has been unable to make annual interest payments for the past 2 years, and the note is due today. Accordingly, Bank legally agreed to restructure Debtors debt as follows: The 30,000 of accrued interest was forgiven. Debtor was given 3 more years to pay off the debt at 8% interest. Payments are to be made annually at year-end. The present value of the payments using the prevailing rate for similar instruments of an issuer with a similar credit rating is 84,018. At the date of the restructuring, Debtor properly records

A. B. C. D.

A loss of 30,000. A gain of 30,000. A gain of 45,982. No gain or loss because no extinguishment occurred.

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Answer (A) is incorrect because 30,000 is the difference between the sum of the existing liabilities and the face amount of the note with modified terms. Moreover, a gain should be recognized. Answer (B) is incorrect because 30,000 is the difference between the sum of the existing liabilities and the face amount of the note with modified terms. Moreover, a gain should be recognized. Answer (C) is correct. Derecognition of a financial liability (or a part thereof) occurs only by means of extinguishment. This condition is satisfied only when the debtor pays the creditor or is legally released from primary responsibility either by the creditor or through the legal process. An extinguishment and derecognition of the old debt and recognition of new debt occurs when the borrower and lender exchange debt instruments with substantially different terms, that is, when the respective discounted cash flows differ by at least 10%. A substantial modification of terms is also accounted for as an extinguishment. The difference between the carrying amount (including unamortized costs) of a liability (or part thereof) that has been extinguished or transferred and the amount paid is included in net profit or loss. This transaction qualifies as an extinguishment based on a substantial modification of terms because the discounted cash flow from the old debt (130,000 due immediately) and the new debt (given as 84,018) differ by at least 10%. Hence, the amount included by Debtor in net profit or loss at the date of the restructuring is a 45,982 gain (130,000 84,018), that is, the difference between the carrying amount extinguished and the amount paid (the present value of the new debt instrument determined by discounting the cash outflows at the prevailing rate for similar instruments of an issuer with a similar credit rating). The entry is to debit the extinguished liability for accrued interest and principal (130,000), debit discount on note payable (15,982), credit note payable (100,000), and credit gain (45,982). Answer (D) is incorrect because the terms were substantially different. Thus, an extinguishment occurred. [527] Gleim #: 4.59 -- Source: CIA 1185 IV-15 An entity received a 2-year, 190,000 note on January 1, 20X2 in exchange for property it sold. According to the terms of the note, interest of 5% is payable annually on January 1, 20X3 and January 1, 20X4, when the face amount is also due. There was no established exchange price for the property. The prevailing rate of interest for a note of this type was 12% at the beginning of 20X2 and 14% at the beginning of 20X3. What interest rates should be used to calculate the amount of interest income from this transaction for the years ended December 31, 20X2 and 20X3, respectively?

A. B. C. D.

0% and 5%. 5% and 5%. 12% and 12%. 12% and 14%. Answer (A) is incorrect because the market rate of interest at the issuance date should be used to calculate the amount of interest income. Answer (B) is incorrect because the market rate of interest at the issuance date should be used to calculate the amount of interest income. Answer (C) is correct. When the nominal interest rate on a note is not equal to the prevailing market rate for this type of note, the face amount of the note is not equal to its fair value or present value. In this case, the present value of the note should be determined by discounting the 190,000 maturity value and the 9,500 annual interest payments using an appropriately imputed rate of interest. Given that 12% was the prevailing rate of interest for a note of that type at the issuance date, 12% should be used to determine both the fair value and the interest income during the life of the note, regardless of fluctuations in prevailing interest rates. Answer (D) is incorrect because the market rate of interest at the issuance date should be used to calculate the amount of interest income.

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[528] Gleim #: 4.60 -- Source: CIA 597 IV-2 During the year, an entitys balance sheet accounts increased by the following amounts: Assets Liabilities Common shares Share premium 180,000 50,000 90,000 15,000

Net profit for the year was 42,000. The only other change in retained earnings was for the declaration of cash dividends. The amount of dividends declared was

A. B. C. D.

2,000 17,000 33,000 67,000 Answer (A) is incorrect because 2,000 ignores the 15,000 increase in share premium. Answer (B) is correct. Assets equals liabilities plus equity. Given an increase of 180,000 in assets, the sum of liabilities and equity must also have increased by 180,000. Because liabilities, share capital, and share premium increased by 155,000 (50,000 + 90,000 + 15,000), retained earnings must have increased by 25,000 (180,000 155,000). Given net profit of 42,000, dividends declared must have been 17,000 (42,000 25,000). Answer (C) is incorrect because 33,000 equals the increase in assets minus the sum of the increases in share capital accounts and net profit. Answer (D) is incorrect because 67,000 equals net profit plus the increase in net assets other than from owner contributions.

[529] Gleim #: 4.61 -- Source: CIA 591 IV-37 At December 31, year 1, an entity had the following equity accounts: Common shares, 10 par, 100,000 shares authorized, 40,000 shares issued and outstanding Share premium from issuance of common shares Retained earnings Total equity

400,000 640,000 1,000,000 2,040,000

Each of the 40,000 common shares outstanding was issued at a price of 26. On January 2, year 2, 2,000 shares were reacquired for 30 per share. The cost method is used in accounting for these treasury shares. Which of the following correctly describes the effect of the acquisition of the treasury shares?

A. B. C. D.

Common shares is reduced by 20,000. Share premium from issuance of common shares is reduced by 32,000. The retained earnings account balance is reduced by 8,000. Total equity is reduced by 60,000.

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Answer (A) is incorrect because the common shares account balance is not affected when treasury shares are acquired. Answer (B) is incorrect because share premium is not affected when treasury shares are acquired and accounted for by the cost method. Answer (C) is incorrect because retained earnings is not affected by treasury share acquisitions when the cost method is used. Answer (D) is correct. Using the cost method, the journal entry to record the acquisition of the treasury shares includes a debit to treasury shares for 60,000. The balance of the treasury shares account is classified as a contra equity item. Thus, the acquisition of the treasury shares reduces total equity by 60,000 (30 2,000 shares = 60,000). [530] Gleim #: 4.62 -- Source: CIA 1188 IV-36 At December 31, year 1, an entity has the following account balances: Common shares (10 par, 50,000 shares issued) 8% preferred shares (50 par, 10,000 shares issued) Share premium on common shares Share premium on preferred shares Retained earnings 500,000 500,000 640,000 20,000 600,000

The preferred shares are cumulative and nonparticipating, and has a call price of 55 per share. The journal entry to record the redemption of all preferred shares on January 2, year 2 pursuant to the call provision is

A. Preferred shares Share premium: preferred Discount on preferred shares Cash B. Preferred shares Share premium: preferred Loss on redemption of preferred shares Cash C. Preferred shares Loss on redemption of preferred shares Retained earnings Cash Share premium: preferred D. Preferred shares Share premium: preferred Retained earnings Cash

500,000 20,000 30,000 550,000 500,000 20,000 30,000 550,000 500,000 50,000 300,000 550,000 300,000 500,000 20,000 30,000 550,000

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Answer (A) is incorrect because the 30,000 excess of cash paid over the carrying amount of the redeemed shares should be debited to retained earnings. Answer (B) is incorrect because the 30,000 excess of cash paid over the carrying amount of the redeemed shares should be debited to retained earnings. Answer (C) is incorrect because the premium on the preferred shares must be debited for only 20,000. Moreover, retained earnings must also be debited for the difference of 30,000. Answer (D) is correct. The exercise of the call provision resulted in the redemption of the 10,000 preferred shares issued and outstanding at the call price of 550,000 (10,000 shares 55 call price per share). To eliminate the carrying amount of the preferred shares and recognize the cash paid in this transaction, the required journal entry is to debit preferred shares for 500,000, debit share premium: preferred for 20,000, and credit cash for 550,000. The difference of 30,000 (550,000 cash 520,000 carrying amount of the preferred shares) is charged to retained earnings. No loss is reported because an Interpretation of IAS 32 does not permit the recognition of a gain or loss on transactions involving an entitys own shares. [531] Gleim #: 4.63 -- Source: Publisher Entity X effects self-insurance against loss from fire by appropriating an amount of retained earnings each year equal to the amount that would otherwise be paid out as fire insurance premiums. The procedure used by entity X is

A. B. C. D.

Prohibited for external reporting purposes. Acceptable provided that fire losses are not charged against the appropriation. Acceptable provided that fire losses are charged against the appropriation. Acceptable if the amount is shown outside the equity section of the balance sheet. Answer (A) is incorrect because an appropriation of retained earnings for self-insurance is permissible. Answer (B) is correct. Accrual of an expense prior to the occurrence of the event for which an entity is self-insured should not be permitted. This rule holds because the fair value of the property diminishes only if the event actually occurs. But an appropriation of retained earnings is acceptable to disclose the self-insurance policy if, when a fire loss occurs, the entry appropriating retained earnings is reversed, and the loss is charged against income of the period of loss and not against retained earnings. Answer (C) is incorrect because fire losses may never be charged against the appropriation of retained earnings. Answer (D) is incorrect because the procedure is acceptable only if the appropriation is shown within the equity section of the balance sheet.

[532] Gleim #: 4.64 -- Source: CIA 580 IV-8 Unlike a share split, a share dividend requires a formal journal entry in the financial accounting records because share

A. B. C. D.

Dividends increase the relative carrying amount of an individuals share holding. Splits increase the relative carrying amount of an individuals share holdings. Dividends are payable on the date they are declared. Dividends represent a transfer from retained earnings to share capital.

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Answer (A) is incorrect because share dividends have no effect on total equity or on the carrying amount of an individual shareholders investment. Answer (B) is incorrect because share splits have no effect on total equity or on the carrying amount of an individual shareholders investment. Answer (C) is incorrect because dividends, whether of shares, cash, or property, are usually payable on a date different from the declaration date. Answer (D) is correct. The purpose of a share dividend is to provide evidence to the shareholders of their interest in accumulated earnings without distribution of cash or other property. Share dividends are typically accounted for by a transfer from retained earnings at fair value. [533] Gleim #: 4.65 -- Source: CMA 695 1-11 Entity UK has 6,000 shares of 5% cumulative, 100 par value preferred shares outstanding and 200,000 common shares outstanding. The board of directors last declared dividends for the year ended May 31, 20X2, and there were no dividends in arrears. For the year ended May 31, 20X4, UK had net profit of 1,750,000. The board of directors is declaring a dividend for common shareholders equivalent to 20% of net profit. The total amount of dividends to be paid by UK at May 31, 20X4 is

A. B. C. D.

350,000 380,000 206,000 410,000 Answer (A) is incorrect because 350,000 is the common shares dividend. Answer (B) is incorrect because 380,000 omits the 30,000 of cumulative dividends for 20X2. Answer (C) is incorrect because 206,000 is based on a flat rate of 1 per share. Answer (D) is correct. If an entity has cumulative preferred shares, all preferred dividends for the current and any unpaid prior years must be paid before any dividends can be paid on common shares. The total preferred dividends that must be paid equal 60,000 (2 years 5% 100 par 6,000 shares), and the common dividend is 350,000 (1,750,000 20%), for a total of 410,000.

[534] Gleim #: 4.66 -- Source: Publisher Early in its fiscal year, Starr purchased 1,000 shares of Pack common shares for 54,000. In the same transaction, Starr acquired 2,000 detachable share purchase warrants. Two of the warrants are required to purchase one additional Pack common share. The market price without the warrants was 49 per share. The market price of the warrants was 3.50 per warrant. Starr sold 50% of the warrants several weeks later. If the proceeds received by Starr equaled 4,000, it recognized a realized gain of

A. B. C. D.

3,000 625 500 0 Answer (A) is incorrect because 3,000 is the excess of the fair value of 2,000 rights over the sale price of 1,000 rights. Answer (B) is correct. The recipient of share purchase warrants should allocate the carrying amount of the shares owned between those shares and the rights based on their relative fair values. Thus, the amounts to be allocated to the common shares and warrants are 47,250 ({(49 1,000) [(49 1,000) + (3.50 2,000)]} 54,000) and 6,750 (54,000 47,250), respectively. The realized gain is therefore 625 [4,000 (6,750 50%)]. Answer (C) is incorrect because 500 equals the excess of the sale price of 1,000 rights over their fair value. Answer (D) is incorrect because Starr should recognize a realized gain for the excess of the price over the carrying amount.

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[Fact Pattern #34] An entity has issued 1,000 common shares with a par value of 10, and its credit balance in retained earnings is 5,000. Two proposals are under consideration. The first is a share split giving each shareholder two new shares for each share formerly held. The second is to declare and distribute a 10% share dividend. [535] Gleim #: 4.67 -- Source: CIA 1194 IV-50 (Refers to Fact Pattern #34) The share split proposal will <List A> earnings per share by <List B> than will the share dividend proposal.

List A A. B. C. D. Increase Increase Decrease Decrease

List B More Less More Less

Answer (A) is incorrect because the split results in a greater number of shares outstanding and a lower EPS than results from the share dividend. Answer (B) is incorrect because the split results in a greater number of shares outstanding and a lower EPS than results from the share dividend. Answer (C) is correct. The share split will double the number of shares outstanding to 2,000. The 10% share dividend will increase the number of outstanding shares to 1,100. The higher number of shares in the split will result in a lower earnings per share than will result from the share dividend. Answer (D) is incorrect because the split results in a greater number of shares outstanding and a lower EPS than results from the share dividend. [536] Gleim #: 4.68 -- Source: CIA 1194 IV-51 (Refers to Fact Pattern #34) Under the share <List A>, the par value per outstanding share will <List B>.

List A A. B. C. D. Dividend Split Dividend Split

List B Increase Increase Decrease Decrease

Answer (A) is incorrect because par value per share does not change following a share dividend. Answer (B) is incorrect because par value per share decreases following a share split. Answer (C) is incorrect because par value per share does not change following a share dividend. Answer (D) is correct. A share split results in a lower par value per share because the total number of shares increases but the total par value of outstanding share does not change. [537] Gleim #: 4.69 -- Source: CIA 595 IV-24 Entity A acquires entity B for 1,000,000. At the time of the acquisition, the net fair value of the identifiable assets, liabilities, and contingent liabilities recognized had a carrying amount of 900,000 and a fair value of 800,000. The amount of goodwill entity A will record on the acquisition date is

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A. B. C. D.

0 100,000 200,000 300,000 Answer (A) is incorrect because goodwill must be recorded. Answer (B) is incorrect because 100,000 is the excess of the acquisition cost over the carrying amount. Answer (C) is correct. Goodwill equals the excess of the acquisition cost over the acquirers interest in the net fair value of the identifiable assets, liabilities, and contingent liabilities recognized. Consequently, goodwill is 200,000 (1,000,000 800,000). Answer (D) is incorrect because 300,000 equals goodwill plus the excess of the carrying amount over fair value.

[538] Gleim #: 4.70 -- Source: CIA 1194 IV-21 A corporation acquires a 30% voting interest in another corporation. In this situation, the long-term investment is generally accounted for on the investor corporations books using which of the following reporting methods?

A. B. C. D.

Lower-of-cost-or-market. Cost. Consolidated. Equity. Answer (A) is incorrect because the lower-of-cost-or-market method is not generally used for equity investments. Answer (B) is incorrect because the cost basis is used when the investor cannot exercise significant influence over the investee (it has less than 20% of the voting power of the investee) and market prices are not readily available. Answer (C) is incorrect because consolidated reporting is ordinarily required only when the investor controls the investee. Answer (D) is correct. If an investor can exercise significant influence over an investee, the investment should be accounted for by the equity method. When a corporation owns 20% or more of the voting power of the investee, the ability to exercise significant influence is presumed.

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[539] Gleim #: 4.71 -- Source: CIA 596 IV-30 A conglomerate company acquired 100% of the net assets of a target company for 900 cash. The target companys balance sheet just prior to the acquisition is presented below. Target Company (as of acquisition date) Carrying Amount Cash Receivables Inventory Property, plant, and equipment (net) Total assets 100 200 150 600 1,050 Fair Value 100 200 200 400 900

Current liabilities Share capital Retained earnings Total liabilities and equity

200 200 650 1,050

200

The amount of goodwill to be recorded by the conglomerate company related to its purchase of the target company is

A. B. C. D.

$(200) $50 $200 None of the answers are correct. Answer (A) is incorrect because goodwill is positive, not negative. Answer (B) is incorrect because $50 is based on carrying amounts. Answer (C) is correct. Goodwill is the excess of the cost over the net fair value of the acquired identifiable assets, liabilities, and contingent liabilities recognized. This net fair value equals the sum of cash, receivables, inventory, and PPE, minus liabilities. Hence, the net fair value acquired is $700, and goodwill is $200 ($900 cost $700). Answer (D) is incorrect because the goodwill recorded is $200.

[540] Gleim #: 4.72 -- Source: CIA 1191 IV-46 Entity X owns 90% of entity Y. Early in the year, X lent Y 1,000,000. No payments have been made on the debt by year-end. Proper accounting at year-end in the consolidated financial statements would

A. B. C. D.

Eliminate 100% of the receivable, the payable, and the related interest. Eliminate 100% of the receivable and the payable but not any related interest. Eliminate 90% of the receivable, the payable, and the related interest. Eliminate 90% of the receivable and the payable but not any related interest.

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Answer (A) is correct. In a consolidated balance sheet, reciprocal balances, such as receivables and payables, between a parent and a consolidated subsidiary should be eliminated in their entirety regardless of the portion of the subsidiarys shares held by the parent. Thus, all effects of the 1,000,000 loan should be eliminated in the preparation of the year-end consolidated balance sheet. Answer (B) is incorrect because the interest must be eliminated. Answer (C) is incorrect because all aspects of the transaction must be eliminated. Answer (D) is incorrect because all aspects of the transaction must be eliminated. [541] Gleim #: 4.73 -- Source: CIA 593 IV-37 An entity issues bonds payable at a premium. You are analyzing the effects of using the effective interest rate (constant yield) method in accounting for the bonds over their 10-year life. Which of the following trends related to the reported amounts for (1) interest expense and (2) carrying amount of the bonds would you expect to find?

Interest Expense A. B. C. D. Constant amount Increasing amount Decreasing amount Decreasing amount

Carrying Amount Constant amount Decreasing amount Decreasing amount Constant amount

Answer (A) is incorrect because the interest expense is a decreasing amount each period. It is computed by applying a constant rate to a decreasing carrying amount. Answer (B) is incorrect because the interest expense is a decreasing amount each period. It is computed by applying a constant rate to a decreasing carrying amount. Answer (C) is correct. When the effective interest rate method is used, interest expense equals the effective rate (a constant rate) times the carrying amount at the beginning of the period. The carrying amount is the par value plus the balance of the unamortized premium. The difference between interest expense and the nominal interest is the premium amortization for the period. Thus, interest expense is a decreasing amount each period because a constant rate is applied to a decreasing carrying amount. Answer (D) is incorrect because the interest expense is a decreasing amount each period. It is computed by applying a constant rate to a decreasing carrying amount. [542] Gleim #: 4.74 -- Source: CIA 590 IV-41 At December 31 of year 1, an entity had a provision of 40,000 for the Estimated Liability under Warranties account. During year 2, the entity sold 1,000 new units under warranties reliably estimated at 100 per unit. The actual parts and labor warranty expenditures for year 2 were 90,000. Warranty expense for year 2 should be

A. B. C. D.

40,000 50,000 90,000 100,000

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Answer (A) is incorrect because 40,000 is the beginning liability balance. Answer (B) is incorrect because 50,000 equals actual expenditures minus the beginning liability. Answer (C) is incorrect because 90,000 equals current-year expenditures. Answer (D) is correct. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated. Accordingly, a provision should be recognized for warranty expense in the period in which the matching revenue is recorded. Thus, the debit to warranty expense and the credit to provision for warranty expense in year 2 is 100,000 (100 1,000 units). [543] Gleim #: 4.75 -- Source: CIA 594 IV-22 Which of the following is required in order for an entity to record a provision?

A. B. C. D.

The exact payee must be known. The exact date payable must be known. It must be reasonably possible that an outflow of resources will be required to settle the obligation. It must be possible to determine a reliable estimate of the amount of the obligation. Answer (A) is incorrect because the exact payee does not have to be known. Answer (B) is incorrect because the exact date payable does not have to be known. Answer (C) is incorrect because the resource outflow must be probable. Answer (D) is correct. A provision is a liability of uncertain timing and amount. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated.

[544] Gleim #: 4.76 -- Source: CIA 593 IV-33 An entity has the following contingencies at a balance sheet date: I. An obligation for clean-up costs relating to environmental damage may, but probably will not, require an outflow of resources. II. An obligation for decommissioning costs of a nuclear reactor may, but probably will not, require an outflow of resources. III. The entity is jointly and severally liable for an obligation arising from a lawsuit; the likelihood of an outflow of resources is remote. Which of the above items must be disclosed in the notes to the financial statements?

A. B. C. D.

I and II only. II and III only. I and III only. I, II, and III.

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Answer (A) is correct. Recognition of provisions is appropriate when the entity has a legal or constructive present obligation resulting from a past event (called an obligating event), it is probable that an outflow of economic benefits will be necessary to settle the obligation, and its amount can be reliably estimated. Thus, none of the circumstances in the question meet the recognition criteria for a provision. Hence, each is treated as a contingent liability, which requires disclosure unless the possibility of the outflow of resources is remote. Answer (B) is incorrect because items I and II but not III should be disclosed. Answer (C) is incorrect because items I and II but not III should be disclosed. Answer (D) is incorrect because items I and II but not III should be disclosed. [545] Gleim #: 4.77 -- Source: CIA 593 IV-34 An entity had the following account balances at December 31 of year 1: Common shares, 10 par, 100,000 shares authorized, 80,000 shares issued and outstanding Share premium Retained earnings

800,000 400,000 500,000

All shares outstanding were issued in a prior period for 15 per share. On January 5 of year 2, 1,000 shares were purchased for the treasury for 17 per share. These treasury shares were sold on February 6 of year 2, for 18 per share. The effect of the purchase and sale of the 1,000 treasury shares was to

A. B. C. D.

Increase equity by 1,000. Increase equity by 2,000. Increase equity by 3,000. Not change equity. Answer (A) is correct. Using the cost method, the journal entry to record the purchase of the treasury shares is

Treasury shares Cash The journal entry to record the sale is Cash Treasury shares Share premium from treasury shares

17,000 17,000

18,000 17,000 1,000

Consequently, the net effect is to increase equity by 1,000. Answer (B) is incorrect because the purchase of treasury shares reduces equity by the cost of the shares, and the sale of treasury shares increases equity by the amount received. Answer (C) is incorrect because the purchase of treasury shares reduces equity by the cost of the shares, and the sale of treasury shares increases equity by the amount received. Answer (D) is incorrect because the purchase of treasury shares reduces equity by the cost of the shares, and the sale of treasury shares increases equity by the amount received. [546] Gleim #: 4.78 -- Source: CIA 1186 IV-29 The proper classification of noncurrent, interest-bearing obligations scheduled to mature within 1 year of the balance sheet date but that are expected to be refinanced on a long-term basis should be to

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A. Exclude all such obligations from the current liabilities classification. B. Include in the current liabilities classification only those obligations that have actually been refinanced on a long-term basis after the balance sheet date but before the financial statements are authorized to be issued. C. Exclude from the current liabilities classification those obligations that have been refinanced on a long-term basis after the balance sheet date but before the financial statements are authorized to be issued. D. Exclude from the current liabilities classification those obligations management wishes to exclude because they intended to convert them to long-term obligations. Answer (A) is incorrect because exclusion is only appropriate when the intent to refinance is properly supported. Answer (B) is incorrect because exclusion is proper in these circumstances given that the intent to refinance has been supported. Answer (C) is correct. Some noncurrent, interest-bearing liabilities due to be settled within 12 months should nevertheless continue to be classified as noncurrent if the original term exceeded 12 months, the entity intends to refinance on a long-term basis, and its intent is supported by an agreement to refinance or reschedule payments. This agreement must be consummated before the financial statements are authorized for issue. Answer (D) is incorrect because managements intent is not sufficient for exclusion. [547] Gleim #: 4.79 -- Source: CMA 688 3-25 In year 1, Voorhees introduced a new line of computer products that carry a 2-year warranty against defects and workmanship. The entity estimates that the total warranty cost will be 10% of sales, with 40% of the expenditures occurring during the first year and 60% during the second year. Sales and actual warranty expenditures for year 1 and year 2 were as follows: Actual Warranty Expenditures 12,000 30,000

Year 1 2

Sales 300,000 400,000

At the end of year 2, the balance in the estimated accrued warranty liability account will be

A. B. C. D.

24,000 46,000 58,000 28,000 Answer (A) is incorrect because the account balance is found by subtracting the actual expenditures from the total expense. Answer (B) is incorrect because the account balance is found by subtracting the actual expenditures from the total expense. Answer (C) is incorrect because the account balance is found by subtracting the actual expenditures from the total expense. Answer (D) is correct. If the warranty expense is 10% of sales, the total expense for the 2 years is 70,000 (10% 700,000). Of that 70,000, 12,000 was paid in year 1 and 30,000 in year 2. The 42,000 of payments leaves an unpaid balance of 28,000 (70,000 42,000).

[548] Gleim #: 4.80 -- Source: CMA 689 3-11 On March 26, Zepher entities contracted with a consultant for services to be performed during the period from March 26 through April 30 in exchange for 10,000 treasury shares. The exchange took place on April 30. The treasury shares were acquired in January, and recorded at cost when the market price was 25 per share. The market price on March 26 was 21.50 per share. It was 23 per share on April 30. The per share amount recorded for the services should have been

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A. B. C. D.

21.50 22.25 23.00 25.00 Answer (A) is correct. A transaction is typically measured at the fair value of the consideration given up unless the fair value of the consideration received is more clearly evident. No information is given about the value of the services, so the market price of the treasury shares must be used. This price was 21.50 on March 26, the date of the agreement to trade the shares for services. Thus, the services to be received should have been measured on that date based on the price of the shares, or 21.50 per share. Because no gain or loss is recognized on transactions in treasury shares, the entry is to debit services for 21,500 (21.50 10,000), debit retained earnings or share premium from treasury share transactions for 3,500 [(25 21.50) 10,000], and credit treasury shares for 25,000 (25 10,000). Answer (B) is incorrect because the services should be measured at the fair value on the date of the exchange. Answer (C) is incorrect because the services should be measured at the fair value on the date of the exchange. Answer (D) is incorrect because the services should be measured at the fair value on the date of the exchange.

[549] Gleim #: 4.81 -- Source: CMA 689 3-13 Muncie sold 1,000 treasury shares at 33 per share. The shares had originally been issued at 12 per share and had been repurchased at 27 per share. The par value is 5 per share. The entry to record the reissuance using the cost method should include a credit to

A. B. C. D.

Retained earnings of 6,000. Treasury shares of 28,000. Paid-in capital in excess of par of 28,000. Share premium of 6,000. Answer (A) is incorrect because share premium should be credited when using the cost method, not retained earnings. Answer (B) is incorrect because the repurchase price was 27 per share. Answer (C) is incorrect because share premium should be credited for only 6,000. Answer (D) is correct. Under the cost method, treasury shares are carried at cost. In this case, cost is 27,000 (27 1,000 shares). The journal entry to record a sale at 33 per share is

Cash Treasury shares Share premium

33,000 27,000 6,000

[550] Gleim #: 4.82 -- Source: CIA 596 IV-24 The effective-interest method and the straight-line method of amortizing a bond discount differ in that the effective-interest method results in

A. B. C. D.

Higher total interest expense over the term of the bonds. Escalating annual interest expense over the term of the bonds. Shrinking annual interest expense over the term of the bonds. Constant annual interest expense over the term of the bonds.

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Answer (A) is incorrect because the two methods of amortization result in the same total interest expense over the term of the bonds. Answer (B) is correct. Under the effective-interest method, interest expense for each period equals the effective interest rate times the carrying value of the bond issue. As the discount is amortized, the carrying value rises and interest expense increases. Answer (C) is incorrect because annual interest expense would decrease if a premium were being amortized. Answer (D) is incorrect because the straight-line method results in constant annual interest expense. [551] Gleim #: 4.83 -- Source: CIA 596 IV-23 On January 1, an entity issued a 10-year 500,000 bond at 96% of its face amount. The bond bears interest at 12%, payable on January 1 and July 1. The entry to record the issuance of the bond on January 1 is

A. Cash Bonds payable B. Cash Bonds payable C. Cash Discount on bonds payable Bonds payable D. Cash Premium on bonds payable Bonds payable

480,000 480,000 500,000 500,000 480,000 20,000 500,000 500,000 20,000 480,000

Answer (A) is incorrect because the entry to bonds payable is based on the face, or maturity, amount of the bond issued. The difference between the amount received on issuance and the face amount is recorded as a premium or discount on bonds payable. Answer (B) is incorrect because the discount should be recognized. Answer (C) is correct. The entity received 480,000 cash on the issuance of the bond. Its face amount is 500,000, the amount to be paid at maturity. Hence, the credit to bonds payable is 500,000. The 20,000 difference is recorded as a discount on bonds payable (a debit) and is amortized over the life of the issue. Answer (D) is incorrect because the debit to cash is 480,000, a 20,000 discount should be debited, and the credit to bonds payable is 500,000. [552] Gleim #: 4.84 -- Source: CIA 596 IV-21 The unit selling price of a new entitys product is 10,000. The buyers are provided with a 2-year warranty that is expected to cost the entity 250 per unit in the year of the sale and 750 per unit in the year following the sale. The entity sold 80 units in the first year of operation and 100 units in the second year. Actual payments for warranty claims were 10,000 and 65,000 in years one and two, respectively. The amount charged to warranty expense during the second year of operation is

A. B. C. D.

25,000 65,000 85,000 100,000

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Answer (A) is incorrect because 25,000 is the expected amount of warranty claims for the first year of second-year sales. Answer (B) is incorrect because 65,000 is the actual amount of claims in the second year. Answer (C) is incorrect because 85,000 is the expected amount of warranty claims in the second year. Answer (D) is correct. Under the accrual method, the total estimated warranty costs are charged to operating expense in the year of sale. The total estimated warranty cost per unit is 1,000 (250 + 750). In year two, 100 units were sold, so the warranty expense recognized is 100,000. [553] Gleim #: 4.85 -- Source: CIA 1191 IV-59 Which of the following brings in additional capital to the firm?

A. B. C. D.

Two-for-one share split. Conversion of convertible bonds to common shares. Exercise of warrants. Exercise of options purchased through an option exchange. Answer (A) is incorrect because a share split is merely an accounting action that increases (or occasionally decreases) the number of shares outstanding. It does not generate additional capital. Answer (B) is incorrect because conversion of convertible bonds to common shares simply replaces debt with outstanding common shares. Answer (C) is correct. Warrants are options that permit the holder to buy shares for a stated price. Their exercise results in inflows and the issuance of shares. Answer (D) is incorrect because options purchased and exercised through option exchanges are transactions between individual investors not affecting the entity whose shares are involved.

[554] Gleim #: 4.86 -- Source: CMA 689 1-9 A sound justification for an entitys repurchase of its own shares (e.g., treasury shares) is to

A. B. C. D.

Lower the debt to equity ratio of the firm. Increase the entitys total assets. Reduce the idle cash and increase marketable securities. Meet the share availability needs of a potential merger. Answer (A) is incorrect because the purchase of treasury shares increases the debt-to-equity ratio. Equity but not debt is reduced by the acquisition. Answer (B) is incorrect because the purchase of treasury shares decreases assets. Cash is paid out and shareholders equity is decreased. Answer (C) is incorrect because treasury shares are recorded as a reduction of equity, not as a marketable security. The theory of this treatment is that an entity cannot own itself. Answer (D) is correct. An entity has many reasons to repurchase its own shares. These include meeting the needs created by potential mergers or pension and profit-sharing plans. Also, management may want to buy out a dissident shareholder. Sometimes, an entity has excess cash and can find no better investment than its own shares. Moreover, management may believe the shares are selling for a low price for no apparent reason. Thus, a purchase may not only be a good investment but may also support the market price of the shares.

[555] Gleim #: 4.87 -- Source: CIA 595 IV-40 Compared with another bond with the same risk and maturity but without a conversion feature, a convertible bond has a

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A. B. C. D.

Higher face amount. Lower face amount. Higher coupon rate. Lower coupon rate. Answer (A) is incorrect because the face amount is not a distinguishing feature of convertible bonds. Answer (B) is incorrect because the face amount is not a distinguishing feature of convertible bonds. Answer (C) is incorrect because convertible bonds have lower, not higher, coupon rates. Answer (D) is correct. Convertible bonds are convertible at the holders option into the issuers common shares at a specified price. They have a lower coupon rate than nonconvertible bonds because they offer investors a chance for capital gains.

[556] Gleim #: 4.88 -- Source: CMA 692 2-21 A contingent asset is

A. B. C. D.

Recognized when condemnation awards are probable or can be reliably estimated. Recognized when damages to be awarded in a copyright infringement suit are highly probable. Recognized when disclosure in the notes to financial statements only could be misleading. Not recognized under any circumstances. Answer (A) is incorrect because contingent assets are not recognized. Answer (B) is incorrect because contingent assets are not recognized. Answer (C) is incorrect because contingent assets are not recognized. If disclosure would be misleading, the disclosure should not be made. Answer (D) is correct. A contingent asset is a possible asset arising from past events and the existence of which will be confirmed only by uncertain future events not wholly within the entitys control. An example is a potential recovery on a legal claim with an uncertain outcome. A contingent asset is not recognized but should be disclosed if an inflow of economic benefits is probable. Disclosures include a description of the contingent asset and an estimate of its financial effects. A contingent asset is not recognized because the income may not be realized. However, if realization is virtually certain, the asset is not contingent and may be recognized.

[557] Gleim #: 4.89 -- Source: Publisher On the first day of the current fiscal year, entity XXX issued 1,000 bonds, each of which is convertible into 100 common shares of the issuer. The face amount of each bond is 1,000, the nominal annual interest rate is 7%, and the market annual interest rate for similar nonconvertible debt is 9%. Interest is payable at the end of each year of the bonds 5-year term. The present values of 1 for 5 periods at 7% and 9% are .713 and .650, respectively. The present values of an ordinary annuity of 1 for 5 periods at 7% and 9% are 4.100 and 3.890, respectively. The fair value of the bonds equity component is not determinable. What is the entry for the initial recognition of the convertible bonds?

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A. Cash Bonds payable B. Cash Bond discount Bonds payable Share capital-equity component of convertible debt C. Cash Bonds payable Share capital-equity component of convertible debt D. Cash Bond discount Bonds payable

1,000,000 1,000,000 1,000,000 77,700 1,000,000

77,700 1,000,000 713,000

287,000 713,000 287,000 1,000,000

Answer (A) is incorrect because the IASs require that the debt and equity components of a compound instrument be separately presented on the issuers balance sheet. Answer (B) is correct. The initial total carrying amount of convertible debt or of debt instruments issued with detachable share purchase warrants should be allocated between the debt instruments and the equity feature, and these debt and equity components should be separately accounted for. The total assigned initially to the instrument as a whole equals the fair value of the consideration received. However, the IFRSs do not stipulate a method for making the allocation. One approach is to assign to the less easily measurable component a residual amount after determining the amount of the more readily measurable component. For example, the future payments on the financial liability might be discounted at the market rate for a similar instrument without an equity feature. This amount would then be subtracted from the amount of the compound instrument as a whole to determine the carrying amount of the equity feature. This method is appropriate when the fair value of the equity feature is not determinable. Thus, the present value of the principal repayment discounted at the market rate of 9% is 650,000 (1,000,000 .650), the present value of the interest payments discounted at 9% is 272,300 [(.07 1,000,000) 3.890], and their total is 922,300. The residual amount assignable to the equity feature is therefore 77,700 [(1,000 par 1,000 bonds) proceeds 922,300 assigned to the debt component], which is also the bond discount given that the convertible bonds were issued at par. Answer (C) is incorrect because the cash flows from the bonds should be discounted at the market rate. Answer (D) is incorrect because the proceeds equaled 1,000,000, the cash flows from the bonds should be discounted at the market rate, and the equity feature should be separately presented. [558] Gleim #: 4.90 -- Source: IIA, adapted A company uses straight-line depreciation for financial reporting purposes, but uses accelerated depreciation for tax purposes. Which of the following account balances would be lower in the financial statements used for tax purposes than it would be in the general purpose financial statements?

A. B. C. D.

Accumulated depreciation. Cash. Retained earnings. Gross fixed assets.

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Answer (A) is incorrect because the balance of accumulated depreciation would be higher in the financial statements for tax purposes, since higher depreciation expense would be reported under accelerated depreciation than under straight-line depreciation. Answer (B) is incorrect because depreciation expense is a non-cash charge. The cash balance is unaffected by the depreciation method used. Answer (C) is correct. Under accelerated depreciation, depreciation expense is higher and net income is lower. Retained earnings would therefore be lower for tax-reporting purposes than for general purpose financial reporting based on straightline depreciation. Answer (D) is incorrect because the historic cost of fixed assets is recorded in the gross fixed assets account. The historic cost of the assets is unaffected by the depreciation method used. [559] Gleim #: 4.91 -- Source: IIA, adapted If bonds are sold at a discount and the effective interest method of amortization is used, interest expense will

A. B. C. D.

Increase from one period to another. Remain constant from one period to another. Equal the cash interest payment each period. Be less than the cash interest payment each period. Answer (A) is correct. Interest expense equals the carrying value of the liability at the beginning of the period times the effective interest rate. The carrying value of the liability equals the face value of the of the bond minus the discount. As the discount is amortized over the life of the bond, the carrying value increases. Consequently, the interest expense increases over the life of the bond. Answer (B) is incorrect because interest expense increases from one period to the next, due to an increased carrying value as the discount is amortized over the life of the bond. Answer (C) is incorrect because interest expense exceeds the cash interest payment. The excess is the amount of discount amortized each period. Answer (D) is incorrect because interest expense exceeds the cash interest payment. The excess is the amount of discount amortized each period.

[560] Gleim #: 4.92 -- Source: CIA 1195 IV-24 Changes in accounting estimates are viewed as

A. B. C. D.

Extraordinary items. Errors in reported amounts in prior periods. Catch-up adjustments related to amounts reported in prior periods. Reassessments of current status and future benefits and obligations. Answer (A) is incorrect because items are not classified as extraordinary under IFRSs. Answer (B) is incorrect because changes in accounting estimates are not errors. Answer (C) is incorrect because catch-up adjustments to prior reported amounts are retroactive. Changes in accounting estimates are accounted for prospectively. Answer (D) is correct. A change in accounting estimate adjusts the carrying amount of an asset or liability or the consumption of an asset. It results from reassessing the status and expected benefits and obligations related to assets and liabilities. It is based on new information and is not an error correction.

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[561] Gleim #: 4.93 -- Source: CIA 597 IV-20 On January 1, 20X1, an entity purchased a machine for 10,000. The estimated useful life was 10 years, with no residual value. The entity depreciates its property, plant, and equipment using the straight-line method. On January 1, 20X5, it was estimated that the machine had a remaining useful life of 3 years. Compute the entitys 20X5 depreciation expense for the machine.

A. B. C. D.

1,000 2,000 3,000 6,000 Answer (A) is incorrect because 1,000 assumes no change in estimate. Answer (B) is correct. The machines net carrying amount at January 1, 20X5 is 6,000 (10,000 cost 4,000 accumulated depreciation for 4 years). A change in accounting estimate is applied prospectively. Thus, depreciation expense is 2,000 per year for the next 3 years. Answer (C) is incorrect because 3,000 assumes a 2-year remaining useful life. Answer (D) is incorrect because 6,000 is the carrying amount at January 1, 2005.

[562] Gleim #: 4.94 -- Source: CIA 597 IV-22 The following financial statement notes are extracts from the audited financial statements of public entities. Which note describes a change in accounting estimate?

A. The entity changed its amortization of capital assets based on a reassessment of the useful lives of the assets. Accordingly, the entity changed its rate of amortization from 5% and 6% to 8% and 10%, for machinery and equipment. B. Prior to 20X5, plant and equipment (other than customer service replacement parts) were depreciated using the diminishing-balance method. Plant and equipment are now depreciated on a straight-line basis. C. During the year, the entity changed a method of accounting pursuant to a change in an International Financial Reporting Standard. D. Effective January 1, 20X5, the entity changed to the LIFO method of inventory valuation. Prior to 20X5, the FIFO method was used. Answer (A) is correct. Accounting estimates, e.g., service lives, residual values, warranty costs, uncollectible accounts, and inventory obsolescence, are a necessary part of preparing financial statements. However, they inevitably change as new events occur and as additional experience and information are obtained. When altered conditions require a change in estimate, it is accounted for prospectively. Thus, a change in the estimate of the service lives of depreciable assets is a change in accounting estimate. Answer (B) is incorrect because a change from diminishing-balance depreciation to straight-line depreciation is a change in accounting policy. Answer (C) is incorrect because changing an accounting method due to a change in an IFRS is a change in accounting policy. Answer (D) is incorrect because LIFO inventory valuation is not permitted under IFRSs. [563] Gleim #: 4.95 -- Source: CIA 596 IV-28 When financial statements are being prepared, which of the following items requires that accountants estimate the effects of future conditions and events?

A. B. C. D.

The purchase price for an acquired building. The price of a marketable security. The amount of recoverable mineral reserves. The physical quantity of inventory.

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Answer (A) is incorrect because the purchase price for an acquired building can be ascertained with certainty. No estimate is required. Answer (B) is incorrect because the price of a marketable security can be calculated with certainty. No estimate is required. Answer (C) is correct. Changes in estimates used in accounting are necessary consequences of periodic presentations of financial statements. Preparing financial statements requires estimating the effects of future events. Examples of items for which estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and residual values of depreciable assets, warranty costs, periods benefited by a deferred cost, and recoverable mineral reserves. Answer (D) is incorrect because the physical quantity of inventory as of the balance sheet date can be measured. Although some estimation of the correct amount may be required, the estimates will not depend on future conditions and events but on current conditions and measurement methods. [564] Gleim #: 4.96 -- Source: CIA 1195 IV-23 In the prior accounting period, an entity incorrectly expensed a newly purchased piece of equipment rather than establishing an asset balance and beginning to depreciate it over the estimated useful life of the item. To correct this material error in the single-period financial statements of the current period, the entity records which entry?

A.

Debit equipment Credit retained earnings Credit accumulated depreciation equipment Debit retained earnings Debit accumulated depreciation equipment Credit equipment

B.

C.

Debit equipment Debit retained earnings Credit accumulated depreciation equipment Debit equipment Debit accumulated depreciation equipment Credit equipment Answer (A) is correct. To correct the prior-period material error, the entity must, in the single-period statements issued for the current period, adjust the affected opening balances. Hence, the entity must debit equipment for its cost and credit accumulated depreciation for the depreciation expense appropriate for the first year of the estimated useful life. Retained earnings must be credited because the error understated profit or overstated loss in the prior period. Answer (B) is incorrect because this entry is the reverse of the correct entry. Answer (C) is incorrect because retained earnings should be credited. Answer (D) is incorrect because accumulated depreciation and retained earnings should be credited.

D.

[565] Gleim #: 4.97 -- Source: CIA 1188 IV-45 A retrospective voluntary change in an accounting policy in the current period should be accounted for in comparative reports by

A. B. C. D.

An adjustment directly to equity balances for the first period presented and restatement of other comparative amounts. A line item on the current income statement for the cumulative effect of the change. Presentation of pro forma comparative information. Note disclosure only in the current period.

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Answer (A) is correct. A voluntary change in accounting policy is applied retrospectively unless it is impracticable to determine period-specific effects or the cumulative effect. Retrospective application means adjusting the opening balances of equity for the first period presented and restating other comparative amounts. Answer (B) is incorrect because reporting the cumulative effect in current profit or loss is not allowed. Answer (C) is incorrect because retrospective application is required to the extent practicable. Answer (D) is incorrect because retrospective application means adjusting the opening balances of equity for the first period presented and restating other comparative amounts. [566] Gleim #: 4.98 -- Source: CMA 681 3-24 An accounting change requiring retrospective treatment is a change in

A. B. C. D.

The residual value of equipment. Depreciation methods from straight-line to diminishing-balance. An accounting policy inseparable from a change in an accounting estimate. A provision for warranty costs. Answer (A) is incorrect because the residual value of equipment is a change in estimate that is accounted for on a prospective basis (in the future). Answer (B) is correct. A change in depreciation methods is reported as a change in accounting policy. A voluntary change in accounting policy is applied retrospectively unless it is impracticable. Retrospective application means adjusting the opening balances of equity for the first period presented and restating other comparative amounts. Answer (C) is incorrect because, if distinguishing between a change in estimate and a change in accounting policy is difficult, the change is accounted for as a change in estimate and properly disclosed. Answer (D) is incorrect because a provision for warranty costs is a change in estimate that is accounted for on a prospective basis (in the future).

[567] Gleim #: 4.99 -- Source: CIA 595 IV-21 An entity changes its method of accounting for depreciation during the current year because it believes that the result will be reliable and more relevant information. In its financial statements for the year, how should the entity report the adjustment resulting from the change in accounting policy if the practicability criterion is met?

A. B. C. D.

Not disclosed in the financial statements. Reported as an adjustment to beginning retained earnings of the earliest period presented. Disclosed as a separate type of depreciation expense, directly following depreciation expense for the current year. Included in the determination of profit or loss for the current period as a cumulative effect adjustment. Answer (A) is incorrect because changes in accounting policies must be disclosed in the financial statements for the period. Answer (B) is correct. Under IAS 8, Accounting Policies, Changes in Estimates and Accounting Errors , a voluntary change in accounting policy should be applied retrospectively unless any resulting adjustment that relates to prior periods is not reasonably determinable. Thus, if it is not impracticable to apply the new policy retroactively, the policy should be applied to comparative information as far back as practicable. The entity should determine the cumulative effect on the opening and closing balance sheets for the earliest period for which it is practicable to do so. Answer (C) is incorrect because the new policy should be retrospectively applied if practicable. Answer (D) is incorrect because retrospective application is required to the extent practicable.

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[568] Gleim #: 4.100 -- Source: CIA 1196 IV-2 If ending inventory is underestimated due to an error in the physical count of items on hand, the cost of goods sold for the period will be <List A> and net earnings will be <List B>.

List A A. B. C. D. Underestimated Underestimated Overestimated Overestimated

List B Underestimated Overestimated Underestimated Overestimated

Answer (A) is incorrect because cost of goods sold will be overestimated. Answer (B) is incorrect because cost of goods sold will be overestimated and profit will be underestimated. Answer (C) is correct. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. If ending inventory is underestimated, cost of goods sold will be overestimated for the period. If cost of goods sold is overestimated, profit for the period will be underestimated. Answer (D) is incorrect because profit will be underestimated. [569] Gleim #: 4.101 -- Source: CIA 1196 IV-3 The failure to record an accrued expense at year-end will result in which of the following overstatement errors in the financial statements prepared at that date?

Profit A. B. C. D. No No Yes Yes

Working Capital No Yes No Yes

Cash Yes No No No

Answer (A) is incorrect because the failure to record an accrued expense will result in an overstatement of profit and an overstatement of working capital and will have no effect on cash. Answer (B) is incorrect because the failure to record an accrued expense will result in an overstatement of profit. Answer (C) is incorrect because the failure to record an accrued expense will result in an overstatement of working capital. Answer (D) is correct. An accrued expense is an expense that has been incurred but not paid. The appropriate adjusting entry to record an accrued expense will increase an expense account and increase a liability account. The failure to record an accrued expense will result in an understatement of expenses leading to an overstatement of profit. The failure to record the increase in a liability account will result in an understatement of current liabilities leading to an overstatement of working capital. There will be no effect on cash. [570] Gleim #: 4.102 -- Source: CIA 1196 IV-31 Which of the following errors is not self-correcting over two accounting periods?

A. B. C. D.

Failure to record accrued wages. Failure to record depreciation. Overstatement of inventory. Failure to record prepaid expenses.

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Answer (A) is incorrect because understatement of accrued wages is a self-correcting error. Future wage expense will be overstated, future cost of goods sold will be overstated, and future expenses will be understated, respectively. Answer (B) is correct. A failure to record depreciation must be corrected because the effects of the error do not automatically reverse in future periods. Expenses are understated in the year of the error, but no corresponding overstatement of expenses occurs in later years. Answer (C) is incorrect because overstatement of inventory and the consequent understatement of cost of goods sold is a selfcorrecting error. Future wage expense will be overstated, future cost of goods sold will be overstated, and future expenses will be understated, respectively. Answer (D) is incorrect because understatement of prepaid expenses (overstatement of expenses) is a self-correcting error. Future wage expense will be overstated, future cost of goods sold will be overstated, and future expenses will be understated, respectively. [571] Gleim #: 4.103 -- Source: CPA 595 F-32 On September 22, 20X2, Yumi Corp. purchased merchandise from an unaffiliated foreign entity for 10,000 units of the foreign entitys local currency. On that date, the spot rate was .55. Yumi paid the bill in full on March 20, 20X3, when the spot rate was .65. The closing rate was .70 on December 31, 20X2. What amount should Yumi report as a foreign currency transaction loss in its income statement for the year ended December 31, 20X2?

A. B. C. D.

0 500 1,000 1,500 Answer (A) is incorrect because a loss resulted when the spot rate increased. Answer (B) is incorrect because 500 results from using the rates at 12/31/X2 and 3/20/X3. Answer (C) is incorrect because 1,000 results from using the rates at 9/22/X2 and 3/20/X3. Answer (D) is correct. A receivable or payable denominated in a foreign currency is adjusted to its current exchange rate at each balance sheet date. The resulting gain or loss should ordinarily be included in determining profit or loss. It is the difference between the spot rate on the date the transaction originates (or the rate applied in the prior year) and the closing rate. Thus, the 20X2 transaction loss for Yumi Corp. is $1,500 [(0.55 0.70) 10,000 units].

[572] Gleim #: 4.104 -- Source: Publisher A reporting entity consolidates a foreign operation. This operation maintains its books in its functional currency, which is not that of a hyperinflationary economy. How should the amounts in the foreign operations financial statements be translated into the presentation currency?

A. B. C. D.

Assets are translated at the exchange rates in effect at the translation dates. All amounts are translated at the closing rate for the most recent balance sheet date. Exchange differences are recognized in equity. Expenses are translated at the closing rate.

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Answer (A) is incorrect because assets and liabilities for each balance sheet presented are translated at the closing rate as of its date. Answer (B) is incorrect because, if the functional currency is that of a hyperinflational economy, translation to a different presentation currency is at the closing rate for the most recent balance sheet for all amounts. Answer (C) is correct. An exchange difference arises when a given amount of one currency is translated into another currency at different exchange rates. Exchange differences are recognized in a separate component of equity when they arise from translation of functional currency amounts into the presentation amounts. Such exchange differences are not recognized in profit or loss because they have little, if any, direct effect on operational cash flows. Answer (D) is incorrect because income and expenses for each income statement presented are translated at the exchange rates at the transaction dates (but an average rate may be used unless rates fluctuate greatly). [573] Gleim #: 4.105 -- Source: Publisher On June 1 of the current year, XYZ Company purchased British pounds for 10,000 foreign currency units (FCUs) for 10,000 euros. It also acquired land for 25,000 euros. At the end of XYZ Companys fiscal year on December 31, the spot rate for the FCU was $1.20 euros. The land had a value of 27,500 euros. XYZ Company records its nonmonetary items at historical cost. Which of the following is the correct presentation of this transaction on XYZ Companys balance sheet?

FCUs A. B. C. D. 10,000 10,000 12,000 12,000

Land 25,000 27,500 25,000 27,500

Answer (A) is incorrect because the FCUs are reported at the spot rate on the date of the balance sheet. Answer (B) is incorrect because the FCUs are reported at the spot rate on the balance sheet date, and the land is valued at the date of purchase. Answer (C) is correct. At the balance sheet date, monetary items are reported at the closing rate, which is often the spot rate on the balance sheet date. Nonmonetary items measured at historical cost are reported at the rate on the transaction date. Thus, the FCUs are reported at 12,000 (1.20 10,000) euros, and the land is reported at 25,000 euros. Answer (D) is incorrect because the land is reported based upon the historical cost on the purchase date. [574] Gleim #: 4.106 -- Source: Publisher Which of the following is true with regard to joint ventures?

A. B. C. D.

The establishment of a separate financial structure is necessary when joint venturers own joint assets. Two venturers are not allowed to transfer assets and liabilities in a given line of business to a jointly controlled entity. When a jointly controlled entity becomes a subsidiary of the venturer, consolidation is required. An investor is a party to the venture who has joint control. Answer (A) is incorrect because jointly controlled assets do not require the establishment of an organization or financial structure separate from the venturers. Answer (B) is incorrect because the venturers may establish a separate entity in which each has an interest and that operates in the same manner as other entities if they choose to have a jointly controlled entity. Answer (C) is correct. A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control. When a jointly controlled entity becomes a subsidiary of the venturer, consolidation is required. Answer (D) is incorrect because an investor is a party to the venture who lacks joint control.

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[575] Gleim #: 4.107 -- Source: Publisher For the past several years, M.F.S. Company has invested in the common stock of Annabelle Company. M.F.S. currently owns approximately 13% of the total of Annabelles outstanding voting common stock. Recently, managements of the two companies have discussed a possible combination of the two entities. If they do decide to combine, the resulting combination should be accounted for as a

A. B. C. D.

Uniting of interests. Purchase. Part purchase, part uniting of interests. Joint venture. Answer (A) is incorrect because the uniting-of-interests method is no longer an acceptable method of accounting for business combinations. Answer (B) is correct. IFRS 3, Business Combinations, requires that all business combinations within its scope be accounted for using the purchase method. Answer (C) is incorrect because accounting for a business combination as part purchase and part uniting of interests is not allowed. Answer (D) is incorrect because a business combination cannot be accounted for as a joint venture. A joint venture requires some form of separate accounting by each venturer.

[576] Gleim #: 4.108 -- Source: CPA 1192 T-33 To effect a business combination initiated on July 1, 20X5, Proper Co. acquired all the outstanding common shares of Scapula Co. for cash equal to the carrying amount of Scapulas net assets. The carrying amounts of Scapulas assets and liabilities approximated their fair values, except that the carrying amount of its building was more than fair value. In preparing Propers December 31, 20X5 consolidated income statement, what is the effect of recording the assets acquired and liabilities assumed at fair value and should goodwill amortization be recognized?

Depreciation Expense A. B. C. D. Lower Higher Lower Higher

Goodwill Amortization Yes Yes No No

Answer (A) is incorrect because depreciation will decrease, and goodwill will be recognized but not amortized. Answer (B) is incorrect because depreciation will decrease, and goodwill will be recognized but not amortized. Answer (C) is correct. A business combination is accounted for as a purchase regardless of the form of consideration given. Under purchase accounting, assets acquired and liabilities assumed should be recorded at their fair values. The differences between fair values and carrying amounts will affect profit or loss when related expenses are incurred. The effect of recording the building at fair value in the consolidated balance sheet instead of its higher carrying amount on Scapulas books will be to decrease future depreciation. If the building is to be used, fair value is its current replacement cost for similar capacity unless expected use indicates a lower value to the acquirer. If the building is to be sold, it should be reported at fair value minus cost to sell. The excess of the cost over fair value of the net assets acquired will be recognized as goodwill, but, under IFRS 3, this amount will be tested for impairment but not amortized. Answer (D) is incorrect because depreciation will decrease, and goodwill is not amortized.

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[577] Gleim #: 4.109 -- Source: CPA 593 II-8 Pellew Corp. paid 600,000 for the outstanding common stock of Samos Co. in a business combination initiated and completed in December 2005. At that time, Samos had the following condensed balance sheet: Carrying Amounts Current assets Plant and equipment, net Liabilities Equity 80,000 760,000 400,000 440,000

The fair value of the plant and equipment was 120,000 more than its carrying amount. The fair values and carrying amounts were equal for all other assets and liabilities. What amount of goodwill, related to Samoss acquisition, should Pellew report in its consolidated balance sheet?

A. B. C. D.

40,000 80,000 120,000 160,000 Answer (A) is correct. A business combination is accounted for as a purchase regardless of the form of the consideration given. Under purchase accounting, assets acquired and liabilities assumed should be recorded at their fair values. Any excess of cost over the fair value of the net assets acquired is recorded as goodwill. After adjusting the net plant and equipment, and given that other items are stated at fair value, the fair value of the net assets acquired is 560,000 [80,000 current assets + (760,000 + 120,000) plant and equipment 400,000 liabilities]. Hence, goodwill is 40,000 (600,000 cost 560,000). Answer (B) is incorrect because 80,000 is the amount of current assets. Answer (C) is incorrect because 120,000 is the amount plant and equipment is undervalued. Answer (D) is incorrect because 160,000 is the difference between the 600,000 cost and the 440,000 carrying amount of the net assets.

[578] Gleim #: 4.110 -- Source: CPA 590 T-33 In a business combination, the sum of the amounts assigned by the acquiring entity to assets acquired and liabilities incurred and assumed exceeds the cost of the acquired entity. The excess should be reported as a

A. B. C. D.

Deferred credit. Reduction of the amounts assigned to current assets and a deferred credit for any unallocated portion. Gain immediately in profit or loss. Pro rata reduction of the amounts assigned to all acquired assets and a gain for any unallocated portion. Answer (A) is incorrect because a deferred credit is never recognized for the excess over cost. Answer (B) is incorrect because the allocated portion is reported as a gain, not as a deferred credit, and the values of the assets are not reduced below fair value. Answer (C) is correct. In a business combination, any excess over cost must be recognized immediately in profit or loss as a gain. Before concluding that an excess over cost has arisen, however, IFRS 3 requires the reassessment of the identification and measurement of the acquirees assets, liabilities, and cost of the combination. Answer (D) is incorrect because the amounts assigned to certain acquired assets (most financial assets, assets to be disposed of by sale, etc.) are not reduced.

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[579] Gleim #: 4.111 -- Source: CIA 594 IV-15 Suppose that an entity has paid one of its liabilities twice during the year, in error. The effects of this mistake would be

A. B. C. D.

Assets, liabilities, and equity are understated. Assets, net income, and equity are unaffected. Assets and liabilities are understated. Assets and net profit and equity are understated, and liabilities are overstated. Answer (A) is incorrect because the double payment of a liability does not affect expenses of the period so it does not affect net profit and equity. Answer (B) is incorrect because assets will be reduced. Answer (C) is correct. When a liability is paid, an entry debiting accounts payable and crediting cash is made. If an entity erroneously pays a liability twice, the accounts payable and cash accounts will be understated by the amount of the liability. Hence, assets and liabilities will be understated. Answer (D) is incorrect because both assets and liabilities will be understated, whereas net profit and equity will be unaffected.

[580] Gleim #: 4.112 -- Source: CIA 1191 IV-45 The present value of future benefits payable as a result of work done before the introduction of, or amendment to, postemployment benefits is the

A. B. C. D.

Additional minimum liability. Fair value of plan assets. Defined benefit obligation. Past service cost. Answer (A) is incorrect because the IASs provide for no additional minimum liability. Answer (B) is incorrect because plan assets are assets held by a separate legal entity (fund) to be used to settle the employee benefit obligation. Answer (C) is incorrect because the defined benefit obligation (DBO) consists of future amounts required to settle the obligation arising from services provided by employees in the current and prior periods. Answer (D) is correct. Past service cost is the increase in the present value of the DBO related to prior employee service that arises in the current period from the introduction of, or an amendment to, postemployment benefits. Past service cost is expensed on a straight-line basis over the average period until vesting. To the extent it is vested upon introduction of, or amendment to, a plan, past service cost is immediately recognized.

[581] Gleim #: 4.113 -- Source: CIA 593 IV-36 An audit of an entity records for its first year of operations determined that the following errors were made at the balance sheet date: Failed to accrue 50,000 interest expense. Failed to record depreciation expense on office equipment of 80,000. Failed to amortize prepaid rent expense of $100,000. Failed to defer recognition of prepaid advertising expense of 60,000.

The net effect of these errors was to overstate net profit by

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A. B. C. D.

130,000 170,000 230,000 290,000 Answer (A) is incorrect because 130,000 ignores the errors related to prepaid rent and prepaid advertising expense. Answer (B) is correct. The computation is as follows:

Error Failure to accrue interest expense Failure to record depreciation Failure to amortize prepaid rent expense Failure to recognize prepaid advertising Totals

Effect on Expense Understate Understate Understate Overstate Understate 50,000 80,000 100,000 60,000 170,000

Effect on Net Profit Overstate Overstate Overstate Understate Overstate 50,000 80,000 100,000 60,000 170,000

Answer (C) is incorrect because 230,000 ignores the error related to prepaid advertising expense. Answer (D) is incorrect because 290,000 treats the error related to prepaid advertising expense as an understatement of expenses. [Fact Pattern #35] An audit of an entity has revealed the following four errors that have occurred but have not been corrected: 1. 2. 3. 4. Inventory at December 31, 2003: 40,000, understated Inventory at December 31, 2004: 15,000, overstated Depreciation for 2003: 7,000, understated Accrued expenses at December 31, 2004: 10,000, understated

[582] Gleim #: 4.114 -- Source: CIA 591 IV-45 (Refers to Fact Pattern #35) The errors cause the reported net profit for the year ending December 31, 2004 to be

A. B. C. D.

Overstated by 72,000. Overstated by 65,000. Understated by 28,000. Understated by 45,000.

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Answer (A) is incorrect because the net effect of these errors was a 65,000 overstatement. Answer (B) is correct. The effect of the understatement of the 2003 year-end inventory (beginning inventory for 2004) was to overstate 2004 net profit by 40,000. The reason is that beginning inventory is a component of cost of sales. The overstatement of the December 31, 2004 inventory overstated 2004 net income by 15,000 because the amounts in ending inventory are excluded from cost of sales. The understatement of 2003 depreciation expense (a nominal account) has no effect on 2004 net income. Finally, the failure to accrue 10,000 of expenses for 2004 overstated 2004 net income. The net effect of these errors was a 65,000 (40,000 + 15,000 + 0 + 10,000) overstatement. Answer (C) is incorrect because the net effect of these errors was a 65,000 overstatement. Answer (D) is incorrect because the net effect of these errors was a 65,000 overstatement. [583] Gleim #: 4.115 -- Source: CIA 591 IV-46 (Refers to Fact Pattern #35) The errors cause the reported retained earnings at December 31, 2004 to be

A. B. C. D.

Overstated by 65,000. Overstated by 32,000. Overstated by 25,000. Understated by 18,000. Answer (A) is incorrect because the net effect of the errors was a 32,000 overstatement. Answer (B) is correct. The 2003 inventory error reversed in 2004 (excluding tax considerations) and therefore had no effect on reported retained earnings at December 31, 2004. The 15,000 inventory error at year-end 2004 and the failure to accrue 10,000 of expenses for 2004 both overstated retained earnings as well as 2004 net profit. The omission of 7,000 of depreciation overstated 2003 net income and 2003 and 2004 retained earnings. Hence, the net effect of the errors on December 31, 2004 retained earnings was a 32,000 (0 + 15,000 + 7,000 + 10,000) overstatement. Answer (C) is incorrect because the net effect of the errors was a 32,000 overstatement. Answer (D) is incorrect because the net effect of the errors was a 32,000 overstatement.

[584] Gleim #: 4.116 -- Source: CMA 690 3-1 For a finance lease, the gross investment, lease payments receivable, recorded by the lessor is equal to the

A. Present value of the minimum lease payments minus the unguaranteed residual value accruing to the lessor at the end of the lease term. B. Lower of 90% of the present value of the minimum lease payments or the fair value of the leased asset. C. Minimum lease payments plus the unguaranteed residual value accruing to the lessor at the end of the lease term. D. Difference between the present value of the minimum lease payments and the unearned finance income. Answer (A) is incorrect because the gross investment is not adjusted for the time value of money or fair value. Answer (B) is incorrect because the gross investment is not adjusted for the time value of money or fair value. Answer (C) is correct. For a finance lease, the lessor should record as the gross investment in the lease the amount of the minimum lease payments (payments plus either any bargain purchase option or any residual value guaranteed by the lessee, a party related to the lessee, or by a financially capable party unrelated to the lessor or the lessee) plus any amounts of unguaranteed residual value. The net investment in the lease is equal to the gross investment, minus unearned finance income. Answer (D) is incorrect because the gross investment is not adjusted for the time value of money or fair value. [585] Gleim #: 4.117 -- Source: CMA 690 3-2 Initial direct costs incurred by the lessor under a finance lease may be

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A. B. C. D.

Allocated over the economic life of the leased asset. Expensed in the period incurred. Deferred and allocated over the term of the lease in proportion to the recognition of rental income. Subtracted from the gross investment in the lease. Answer (A) is incorrect because initial direct costs of a finance lease may be allocated over the lease term or recognized immediately. Answer (B) is correct. The initial direct costs of entering into a finance lease, e.g., commissions and legal fees, may be recognized immediately or allocated over the lease term. One possibility is to recognize the expense as incurred while also recognizing as income in the same period an equal amount of the unearned finance income. Answer (C) is incorrect because initial direct costs of an operating lease may be deferred and allocated over the term of the lease in proportion to the recognition of rental income. Answer (D) is incorrect because initial direct costs of a finance lease are recognized immediately in income or allocated over the lease term.

[586] Gleim #: 4.118 -- Source: CIA 589 IV-41 A new asset with a fair value of 100,000 and a useful life of 10 years is being leased by an entity (lessee). Which of the situations below will most likely result in classifying the lease on the lessees books as a finance lease?

A. B. C. D.

The lease term is 7 years. The lease term is 8 years. The present value of the minimum lease payments is 60,000. The present value of the minimum lease payments is 70,000. Answer (A) is incorrect because a 7-year lease term is less likely to be for the major part of the economic life of the asset than an 8-year lease term. Answer (B) is correct. A lease may be classified as either a finance lease or an operating lease by a lessee. A finance lease transfers substantially all of the risks and rewards of ownership of the asset to the lessee. A lease is classified at its inception. It normally is classified as a financial lease if, for example, 1. The lease provides for the transfer of ownership of the asset by the end of the lease term. 2. The lease contains a bargain purchase option; i.e., the lessee has the option to purchase at a price expected to be sufficiently below the fair value of the exercise date that, at the leases inception, exercise is reasonably certain. 3. The lease term is for the major part of the economic life of the asset. 4. The present value of the minimum lease payments is at least substantially all of the fair value of the leased asset at the inception of the lease. 5. The leased assets are such that they can be used only by the lessee without major modification. Thus, a lease term that is 80% (8 10) of the economic life of the asset will most likely result in classifying the lease as a finance lease, assuming that 80% is a major part of the economic life of the asset. Answer (C) is incorrect because a present value of the minimum lease payments of only 60,000 is not substantially all of the fair value of the leased asset. Answer (D) is incorrect because a present value of the minimum lease payments of only 70,000 is not substantially all of the fair value of the leased asset.

[587] Gleim #: 4.119 -- Source: CMA 1291 2-27 On December 31, 2003, Johnson sold on account and shipped merchandise with a list price of 75,000 to Gibsen. The terms of the sale were n/30, FOB shipping point. The merchandise arrived at Gibsen on January 5, 2004. Because of confusion about the shipping terms, the sale was not recorded until January of 2004 and the merchandise, sold at a markup of 25% of cost, was included in Johnsons inventory on December 31, 2003. Johnson uses a periodic inventory system. As a result of the above, Johnsons profit before income taxes for the year ended December 31, 2003 was

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A. B. C. D.

Understated by 15,000. Understated by 75,000. Understated by 18,750. Overstated by 60,000. Answer (A) is correct. The shipping term was FOB shipping point. Hence, title to the goods and risk of loss passed to the buyer on December 31, 2003, and the 75,000 sale should have been recorded on that date. Given a selling price of 75,000 and a markup on cost of 25%, cost must have been 60,000 (75,000 1.25), and profit before taxes must have been 15,000 (75,000 60,000). Because the sale was unrecorded, the sellers balance sheet reflected inventory of 60,000 instead of an account receivable of 75,000. Thus, assets were understated by 15,000. Also, profit was understated by 15,000 because of the failure to credit sales for 75,000 and debit cost of goods sold for 60,000. Answer (B) is incorrect because income was understated by 15,000. Answer (C) is incorrect because income was understated by 15,000. Answer (D) is incorrect because income was understated by 15,000.

[588] Gleim #: 4.120 -- Source: CIA 592 IV-52 Finance leases are differentiated from operating leases in that finance leases normally

A. B. C. D.

Provide for maintenance service at no extra cost to the lessee. Are cancelable at any time upon request by the lessee. Have rental payments that are approximately equal to the amortized cost of the leased asset. Are used only by financial institutions. Answer (A) is incorrect because finance leases do not normally provide for maintenance service. Answer (B) is incorrect because finance leases are not normally cancelable. Answer (C) is correct. A lease may be classified as either a finance lease or an operating lease by a lessee. A finance lease transfers substantially all of the risks and rewards of ownership of the asset to the lessee. A lease is classified at its inception. It normally is classified as a finance lease if, for example, 1. The lease provides for the transfer of ownership of the asset by the end of the lease term. 2. The lease contains a bargain purchase option; i.e., the lessee has the option to purchase at a price expected to be sufficiently below the fair value of the exercise date that, at the leases inception, exercise is reasonably certain. 3. The lease term is for the major part of the economic life of the asset. 4. The present value of the minimum lease payments is at least substantially all of the fair value of the leased asset at the inception of the lease. 5. The leased assets are such that they can be used only by the lessee without major modification. Thus, the rental payments tend to approximate the cost of the leased property plus a return on the investment. Answer (D) is incorrect because finance leases are used by entities in various industries.

[589] Gleim #: 4.121 -- Source: CMA 1293 2-10 For the past three years, Colbeth entities has failed to accrue unpaid wages earned by workers during the last week of the year. The amounts omitted, which are considered material, were as follows. December 31, 2001 December 31, 2002 December 31, 2003 56,000 51,000 64,000

The entry on December 31, 2003 to correct for these omissions includes a

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A. B. C. D.

Credit to wage expense for 64,000. Debit to wage expense for 51,000. Debit to wage expense for 13,000. Credit to retained earnings for 64,000. Answer (A) is incorrect because 64,000 is the total accrued wages payable, not the amount of the adjustment. Answer (B) is incorrect because 51,000 was the correct wage accrual for 2002. Answer (C) is correct. Failing to record accrued wages is a self-correcting error. Expenses are understated in one year and overstated in the next, resulting in the correction of the error over the 2-year period. The 2001 error overstated 2001 earnings and understated 2002 earnings by 56,000. Consequently, no correction is necessary for the 2001 error. The 2002 error overstated 2002 profit before taxes and understated 2003 profit before taxes by 51,000. The 2003 error overstated 2003 profit before taxes by 64,000. Thus, the net effect in 2003 of the 2002 and 2003 errors is a 13,000 (64,000 51,000) overstatement. The correcting entry is to debit expense for 13,000, debit retained earnings for 51,000, and credit wages payable for 64,000. Answer (D) is incorrect because retained earnings should be debited because of the overstatement of 2002 income.

[Fact Pattern #36] During the year ended December 31, 2003, an entity had 500,000 in sales revenue and purchased 150,000 of inventory. The cost of goods sold was 250,000 for the year, and the entity incurred 25,000 of general and administrative expenses. The January 1, 2003 opening balance sheet was as follows:

Cash Accounts receivable Inventory Fixed assets (gross) Accum. depreciation Net fixed assets Total assets Accounts payable Long-term debt Common shares Retained earnings Total liabilities and equity

120,000 100,000 200,000 600,000 (100,000) 500,000 920,000 220,000 400,000 100,000 200,000

920,000

The cost of long-term debt financing is 10% per annum, payable in one installment on December 31 of each year. The entity has a 50% tax rate. The entity has a dividend payout ratio of 25%. The fixed assets were 1-year old at the start of the current year, were originally estimated to have a 6-year useful life, and are being depreciated on the straight-line basis. [590] Gleim #: 4.122 -- Source: CIA 1194 IV-1 (Refers to Fact Pattern #36) The entity has a closing inventory balance of

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A. B. C. D.

100,000 250,000 300,000 350,000 Answer (A) is correct. Ending inventory equals beginning inventory, plus purchases, minus cost of goods sold. Thus, ending inventory is 100,000 (200,000 + 150,000 250,000). Answer (B) is incorrect because 250,000 is the cost of goods sold. Answer (C) is incorrect because 300,000 results from adding cost of goods sold to beginning inventory and subtracting purchases. Answer (D) is incorrect because 350,000 equals beginning inventory plus purchases.

[591] Gleim #: 4.123 -- Source: CIA 1194 IV-2 (Refers to Fact Pattern #36) If the entity had purchased a larger amount of inventory during the year, with the additional items being purchased on December 31, 2003, what is the effect on cost of goods sold and on net profit for the year?

Cost of Goods Sold A. B. C. D. Increase Increase Decrease No effect

Net Profit Decrease Increase Increase No effect

Answer (A) is incorrect because cost of goods sold and net profits are unaffected. Answer (B) is incorrect because cost of goods sold and net profits are unaffected. Answer (C) is incorrect because cost of goods sold and net profits are unaffected. Answer (D) is correct. Cost of goods sold equals beginning inventory, plus purchases, minus ending inventory. If a purchase is made on December 31, purchases and ending inventory should increase by the same amount. Thus, cost of goods sold is unaffected. Because cost of goods sold is unaffected, net profit is also unaffected. [592] Gleim #: 4.124 -- Source: CIA 1194 IV-3 (Refers to Fact Pattern #36) The entity will pay dividends for the year of

A. B. C. D.

10,625 21,250 23,125 42,500 Answer (A) is correct. The entity has a dividend payout ratio of 25% of net profit. Profit before taxes is 85,000 [500,000 sales 250,000 CGS 25,000 G&A expenses (10% interest rate 400,000 LT debt) (600,000 fixed assets 6 years)]. Hence, after-tax net profit is 42,500 [(1.0 .5) 85,000], and the dividend payout is 10,625 (25% 42,500). Answer (B) is incorrect because 21,250 uses a 50% dividend payout ratio instead of 25%. Answer (C) is incorrect because 23,125 calculates net profit without subtracting the 100,000 depreciation expense. Answer (D) is incorrect because 42,500 is the after-tax net profit.

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[593] Gleim #: 4.125 -- Source: CIA 1194 IV-6 (Refers to Fact Pattern #36) What would be the effect of a lower tax rate on the ending balance of common shares and on dividends paid for the year?

Ending Balance of Common Shares A. B. C. D. Increase Decrease No effect No effect Dividends Paid Increase Decrease Increase Decrease

Answer (A) is incorrect because the common shares account is not affected, but dividends will increase. Answer (B) is incorrect because the common shares account is not affected, but dividends will increase. Answer (C) is correct. The balance in the common shares account represents share capital, i.e., capital contributed by owners, not earnings retained in the business. It is not affected by a change in tax rate. Dividends will increase, however, because they are a constant percentage of after-tax earnings. Answer (D) is incorrect because the common shares account is not affected, but dividends will increase. [594] Gleim #: 4.126 -- Source: CIA 1194 IV-22 How are material prior-period errors in financial statements accounted for when comparative statements are issued?

A. B. C. D.

They are included in the determination of net profit or loss for the current period. Prior-period financial statements are adjusted and reissued. They are corrected by restating comparative amounts for years when errors occurred. They are charged or credited directly to the closing balance of current-year retained earnings. Answer (A) is incorrect because errors are excluded from the determination of current period profit or loss. Answer (B) is incorrect because prior-period financial statements need not be reissued. However, if comparative statements are presented, the prior-period statements must be restated if it is practicable to do so. Answer (C) is correct. All material prior-period errors must be corrected retrospectively in the first set of financial statements issued after their discovery. This may be done by restating the comparative amounts for the prior periods when the error occurred. If the error occurred prior to the first period presented, the opening balances for the first period presented are restated. A material error is one that could, individually or collectively, affect the decisions of users of the financial statements. However, comparative information should be restated only if practicable. Answer (D) is incorrect because errors are adjustments of the current years opening balance of retained earnings and other relevant balances.

[595] Gleim #: 4.127 -- Source: CIA 1194 IV-40 A change in an accounting estimate is shown on the income statement

A. B. C. D.

Only in the relevant account. In a separate section entitled extraordinary items. In a separate section after continuing operations but before extraordinary items. As a cumulative-effect adjustment.

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Answer (A) is correct. A change in an accounting estimate is accounted for prospectively and is shown on the income statement only in the relevant account. The effect of the change is included in the same income statement classification as the previous estimate. However, prior-period statements and opening balances are not adjusted. Answer (B) is incorrect because changes in an accounting estimate are not extraordinary, that is, clearly distinct from the ordinary activities of the entity. Answer (C) is incorrect because changes in accounting estimates are shown only in the relevant accounts. The effect of the change is included in the same income statement classification as the previous estimate. Answer (D) is incorrect because a change in an accounting estimate is only shown in the relevant account. The effect of the change is included in the same income statement classification as the previous estimate. No cumulative effect of the change is recognized because estimates are accounted for prospectively. [596] Gleim #: 4.128 -- Source: CIA 595 IV-26 An entity has 100 of current assets, 100 of fixed assets, 100 of debt, and 100 of equity. If it then leases a 75 asset in a(n) <List A> lease agreement, the debt-to-assets ratio of the entity will be <List B>

List A A. B. C. D. Operating Operating Finance Finance

List B 64% 00% 50% 64%

Answer (A) is incorrect because 64% is the debt-to-assets ratio if the lease is a finance lease. Answer (B) is incorrect because 100% is the debt-to-equity ratio if the lease is an operating lease. Operating leases are treated as rental agreements, and neither the asset nor the obligation for future payments is recorded on the balance sheet. The balance of debt remains at 100, so the debt-to-equity ratio is 100% (100 100). Answer (C) is incorrect because 50% is the debt-to-assets ratio if the lease is an operating lease. Answer (D) is correct. If the lease is a finance lease, both the asset and the obligation for future payments are recorded. The entity would have current assets of 100, debt of 175 (100 + 75), fixed assets of 175 (100 + 75), and equity of 100. Hence, the debt-to-assets ratio would be 64% (175 275). [597] Gleim #: 4.129 -- Source: CIA 1195 IV-1 If certain goods owned by an entity were not recorded as a purchase and were not counted in ending inventory, in error, then

A. B. C. D.

Cost of goods sold for the period will be understated. Cost of goods sold for the period will be overstated. Profit for the period will be understated. There will be no effect on cost of goods sold or net profit for the period. Answer (A) is incorrect because the errors offset each other, so cost of goods sold is not understated or overstated for the period. Answer (B) is incorrect because the errors offset each other, so cost of goods sold is not understated or overstated for the period. Answer (C) is incorrect because cost of goods sold is unaffected by the error, so profit is also unaffected. Answer (D) is correct. The effects of the errors on cost of goods sold are offsetting. Purchases, which increase cost of goods sold, and ending inventory, which decreases cost of goods sold, are understated by the same amount. Neither cost of goods sold nor profit is affected.

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[598] Gleim #: 4.130 -- Source: CIA 1195 IV-25 Because changes in accounting estimates relate to changes in circumstances in the [List A] period, they should be reported [List B].

List A A. B. C. D. Current Current Prior Prior

List B Not at all Prospectively Retroactively Not at all

Answer (A) is incorrect because changes in accounting estimates should be reported. Answer (B) is correct. Changes in accounting estimates arise as new events occur, as more experience is obtained, or as additional evidence is acquired. A change should be reported in the period in which it occurs, as well as prospectively if future periods are affected. Retroactive reporting is impracticable because it would result in continual adjustments of prior years financial statements. Answer (C) is incorrect because changes in accounting estimates arise from changes in current, not prior, circumstances. Answer (D) is incorrect because changes in accounting estimates arise from changes in current, not prior, circumstances. [599] Gleim #: 4.131 -- Source: CIA 1195 IV-26 Under a defined contribution postemployment benefit plan, a(n) [List A] is reported on the balance sheet only if the amount the employer has contributed to the pension trust fund is [List B] the amount required.

List A A. B. C. D. Asset Asset Liability Liability

List B Greater than Equal to Greater than Equal to

Answer (A) is correct. Under a defined contribution plan, the employer recognizes an expense and a liability for the contribution payable in exchange for an employees services performed during the period. The amount is determined after subtracting any contribution already made. However, if the contribution made exceeds the amount due, the excess is treated as a prepaid expense. Answer (B) is incorrect because an asset is reported only if the contribution is in excess of the amount required. Answer (C) is incorrect because the employer reports a liability only if the contribution is less than the required amount. Answer (D) is incorrect because the employer reports a liability only if the contribution is less than the required amount. [600] Gleim #: 4.132 -- Source: CIA 589 IV-32 An entity incurred the following costs during its first year of operation. Legal fees in connection with establishing the legal entity Pre-opening costs of the new business Operating losses

100,000 200,000 400,000

During its second and later years, the entity became profitable. It amortizes start-up costs using the straight-line method over a 5-year period. What is the correct amount of amortization expense for start-up costs during the second year of the life of the entity?

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A. B. C. D.

20,000 40,000 60,000 0 Answer (A) is incorrect because current-year start-up costs are expensed as incurred. Answer (B) is incorrect because current-year start-up costs are expensed as incurred. Answer (C) is incorrect because current-year start-up costs are expensed as incurred. Answer (D) is correct. In some circumstances, expenditures may be made to provide future economic benefits, but no intangible asset results that is recognized. Accordingly, such expenditures should be expensed as incurred. Examples include expenditures for start-up costs (start-up activities), such as legal and secretarial costs of establishing a legal entity, pre-opening costs of a new facility or business, or pre-operating costs of commencing new operations or marketing new products. Thus, the entity should have expensed the full amount of the start-up costs in the first year. No amortization expense should be recognized in the second year. Moreover, to correct this error, an adjustment should be made to the opening balance of current year retained earnings and other relevant balances, unless any resulting adjustment relating to prior periods is not practicable.

[601] Gleim #: 4.133 -- Source: Publisher Mill, which began operations on January 1, 20X1, recognizes income from long-term construction contracts under the percentage-of-completion method in its financial statements and under the completed-contract method for tax reporting. Income under each method follows: CompletedContract -400,000 700,000 Percentageof-Completion 300,000 600,000 850,000

Year 20X1 20X2 20X3

There are no other temporary differences. If the applicable tax rate is 25%, Mill should report in its balance sheet at December 31, 20X3 a deferred income tax liability of

A. B. C. D.

87,500 125,000 162,500 37,500 Answer (A) is incorrect because 87,500 ignores the difference for 20X1. Answer (B) is incorrect because 125,000 ignores the difference for 20X3. Answer (C) is correct. In its financial statements issued through December 31, 20X3, Mill has reported 1,750,000 (300,000 + 600,000 + 850,000) of income from long-term contracts. In its tax returns for the same period, it has reported 1,100,000 (400,000 + 700,000) of income from the same sources. The result is a taxable temporary difference. Thus, Mill expects to have future taxable amounts of 650,000 and should recognize a deferred tax liability of 162,500 (25% applicable tax rate 650,000). Answer (D) is incorrect because 37,500 ignores the differences for 20X1 and 20X2.

[602] Gleim #: 4.134 -- Source: Publisher A deferred tax asset is recognized for

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A. Goodwill if its amortization is nondeductible for tax purposes. B. The initial recognition of an asset that is not part of a business combination and does not affect accounting profit or taxable profit at the date of the transaction. C. A deductible temporary difference if the future availability of taxable profit is probable. D. Negative goodwill treated as deferred income. Answer (A) is incorrect because a deferred tax liability (DTL) is recognized for most taxable TDs. However, no DTL is recognized when it arises from goodwill if the amortization of the goodwill is not deductible for tax purposes. The reason is that the recognition of a DTL would increase goodwill. In a business combination that is an acquisition, goodwill equals the excess of the acquisition cost over the acquirers interest in the net fair value of the identifiable net assets, liabilities, and contingent liabilities recognized. Answer (B) is incorrect because neither a deferred tax liability nor a deferred tax asset is recognized in these circumstances. Answer (C) is correct. A deferred tax asset is recognized for most deductible TDs and for the carryforward of unused tax losses and credits, but only to the extent it is probable that taxable profit will be available to permit the use of those amounts. Answer (D) is incorrect because no DTA is recognized when it arises from an excess over cost (negative goodwill) treated as deferred income. The reason is that the recognition of a DTA would increase an excess over cost. In a business combination that is an acquisition, an excess over cost equals the excess of the acquirers interest in the net fair value of the identifiable assets, liabilitiies, and contingent liabilities recognized over the acquisition cost. [603] Gleim #: 4.135 -- Source: Publisher At the beginning of year 1, Cody Construction began work on a 3-year construction contract. This contract is accounted for by the percentage-of-completion method for financial accounting purposes and the completed-contract method for tax purposes. During year 1, Cody reported 800,000 of income from this contract. However, because of cost overruns incurred in year 2, Cody reported a 500,000 loss from this contract. Codys year 2 balance sheet should include a

Deferred Tax Asset A. B. C. D. Yes Yes No No

Deferred Tax Liability Yes No No Yes

Answer (A) is incorrect because a taxable temporary difference usually results in a deferred tax liability in the current period. Answer (B) is incorrect because a taxable temporary difference usually results in a deferred tax liability in the current period. Answer (C) is incorrect because a taxable temporary difference usually results in a deferred tax liability in the current period. Answer (D) is correct. A deferred tax liability is recognized for the deferred tax consequences attributable to most taxable temporary differences. A deferred tax asset is recognized for the deferred tax consequences attributable to most deductible temporary differences, but only to the extent it is probable that taxable profit will be available to permit the use of those amounts. At the end of year 2, the cumulative effect of the difference in accounting for financial reporting and tax purposes is a 300,000 (800,000 500,000) temporary difference. Because this 300,000 temporary difference will result in future taxable amounts, it is a taxable temporary difference for which a deferred tax liability is recognized.

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[Fact Pattern #37] The following relates to Lally Plc for 20X1 and 20X2.

20X2 Profit before income taxes Interest income included above that was not subject to income taxes 5,000,000 100,000

20X1 4,000,000 100,000

Profit before income taxes in 20X1 included rent income of 80,000 that was not subject to income tax until its receipt in 20X2. Lally was subject to an effective income tax rate of 40% in 20X1 and 20X2. [604] Gleim #: 4.136 -- Source: CMA 686 3-7 (Refers to Fact Pattern #37) The tax expense that would have been reported on Lallys income statement for the year ended December 31, 20X1 is

A. B. C. D.

1,560,000 1,528,000 1,600,000 1,568,000 Answer (A) is correct. Tax expense (tax income) equals the sum of current tax expense (current tax income) and deferred tax expense (deferred tax income). Current tax expense equals taxes paid or payable, and deferred tax expense equals the change in the entitys deferred tax assets and liabilities. Because 100,000 of interest income and 80,000 of rental income are not subject to tax in 20X1, taxable profit is 3,820,000, and current tax expense is 1,528,000. Deferred tax expense equals the deferred tax liability (40% 80,000 = 32,000) at year-end, assuming no deferred tax asset or liability balances existed at the beginning of the year. Hence, tax expense is 1,560,000 (1,528,000 + 32,000). Answer (B) is incorrect because 1,528,000 does not include tax on the rent income. Answer (C) is incorrect because 1,600,000 includes tax on the tax-exempt interest. Answer (D) is incorrect because 1,568,000 includes tax on the tax-exempt interest but does not include tax on the rent income.

[605] Gleim #: 4.137 -- Source: CMA 686 3-9 (Refers to Fact Pattern #37) Lallys current tax expense for 20X2 was

A. B. C. D.

1,960,000 1,992,000 2,000,000 2,032,000 Answer (A) is incorrect because 1,960,000 does not include the deferred tax liability from the rent. Answer (B) is correct. The 5,000,000 of pre-tax profit is reduced by the 100,000 of interest income not subject to tax. However, the rental income accrued in the previous year is taxable in 20X2. Thus, the profit subject to tax is 4,980,000. Given a 40% rate, the current tax expense is 1,992,000. Answer (C) is incorrect because 2,000,000 includes the tax-exempt interest but does not include the deferred tax liability from the rent. Answer (D) is incorrect because 2,032,000 includes the tax-exempt interest.

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[606] Gleim #: 4.138 -- Source: CMA 686 3-10 (Refers to Fact Pattern #37) The deferred tax asset or liability reported on Lallys balance sheet on December 31, 20X2 is

A. B. C. D.

40,000 32,000 8,000 0 Answer (A) is incorrect because the non-taxable interest income does not have deferred tax consequences. The rental income created a deferred tax liability in 20X1 that reversed in 20X2. Therefore, no deferred tax amount existed at the end of 20X2. Answer (B) is incorrect because the non-taxable interest income does not have deferred tax consequences. The rental income created a deferred tax liability in 2