Sample Questions
Question 1
Easy
The notes to the financial statements are important because they:
Solution
C is correct.
Footnotes disclose the accounting policies used, significant estimates and judgments, contingent liabilities, related-party transactions, and other details essential for understanding the financial statements. They are integral to the financial statements and subject to audit.
Footnotes disclose the accounting policies used, significant estimates and judgments, contingent liabilities, related-party transactions, and other details essential for understanding the financial statements. They are integral to the financial statements and subject to audit.
Question 2
Medium
Free cash flow to the firm (FCFF) is best calculated as:
Solution
B is correct.
FCFF represents cash available to all capital providers (debt and equity holders). Starting from net income: FCFF = NI + Non-cash charges (e.g., depreciation) + Interest expense × (1 − t) − Changes in working capital − Capital expenditures. Adding back after-tax interest is necessary because net income is after interest expense, but FCFF is a pre-financing measure.
FCFF represents cash available to all capital providers (debt and equity holders). Starting from net income: FCFF = NI + Non-cash charges (e.g., depreciation) + Interest expense × (1 − t) − Changes in working capital − Capital expenditures. Adding back after-tax interest is necessary because net income is after interest expense, but FCFF is a pre-financing measure.
Question 3
Hard
A deferred tax liability most likely arises when:
Solution
C is correct.
A deferred tax liability (DTL) arises when pretax accounting income exceeds taxable income in the current period, creating a temporary difference that will reverse in the future. The company pays less tax now but expects to pay more later (e.g., when using accelerated depreciation for tax purposes but straight-line for financial reporting).
A deferred tax liability (DTL) arises when pretax accounting income exceeds taxable income in the current period, creating a temporary difference that will reverse in the future. The company pays less tax now but expects to pay more later (e.g., when using accelerated depreciation for tax purposes but straight-line for financial reporting).
