Welcome to CFA Level I Financial Reporting & Analysis (FRA) Part 3 (Q101–150). This section continues our in-depth series of CFA Level I practice questions, designed to help candidates strengthen their exam preparation with realistic, exam-style MCQs. Each question includes detailed explanations, ensuring you not only practice but also build strong conceptual clarity. FRA is one of the weightiest topics in the CFA Level I curriculum, making it essential for success. Use this resource to sharpen your skills in deferred taxes, OCI, leverage ratios, cash flows, and earnings quality.
Part 3: Practice MCQs (Q101–150)
Q101.
Under IFRS, which of the following costs can be capitalized as part of inventory?
A. General administrative costs
B. Selling and distribution expenses
C. Storage costs (except during production)
D. Conversion costs (direct labor, overheads)
Answer: D
Explanation: Under IFRS, inventory includes costs of purchase, conversion (direct labor + allocated overheads), and other costs to bring inventory to its present condition. Administrative and selling costs are expensed, and storage costs are expensed unless necessary during production.
Q102.
Which method is allowed under IFRS but not permitted under U.S. GAAP for inventory valuation?
A. FIFO
B. Weighted average
C. LIFO
D. Specific identification
Answer: C
Explanation: LIFO (Last-In, First-Out) is prohibited under IFRS but permitted under U.S. GAAP. This difference is tested heavily in CFA FRA.
Q103.
If prices are rising, which inventory method results in the highest gross profit?
A. FIFO
B. LIFO
C. Weighted Average
D. Moving Average
Answer: A
Explanation: Under inflation, FIFO matches older, cheaper costs against current revenues → higher gross profit and net income. LIFO shows lower profit but lower taxes under GAAP.
Q104.
Which of the following statements about impairment testing is correct under IFRS?
A. Reversals of impairment are not allowed
B. Impairment is tested at the asset level only
C. Impairment is tested at the cash-generating unit (CGU) level
D. Goodwill impairment can be reversed
Answer: C
Explanation: IFRS tests impairment at the CGU level, not just individual assets. Reversals (except for goodwill) are allowed under IFRS, unlike GAAP which prohibits reversals.
Q105.
Which ratio best measures a company’s efficiency in managing its receivables?
A. Current ratio
B. Quick ratio
C. Days sales outstanding (DSO)
D. Cash ratio
Answer: C
Explanation: DSO (Receivables ÷ Average daily sales) indicates how quickly a company collects from customers. Lower DSO = better efficiency.
Q106.
A firm reports higher depreciation expense under double declining balance compared to straight-line. Which of the following will be true?
A. Net income will be higher
B. Asset turnover ratio will decrease
C. Return on assets (ROA) will decrease initially
D. Operating cash flow will decrease
Answer: C
Explanation: Accelerated depreciation reduces net income and ROA early on. However, operating cash flows remain unaffected since depreciation is non-cash.
Q107.
Which of the following is a limitation of ratio analysis?
A. Ratios are standardized across industries
B. They always provide future predictions
C. They are affected by accounting policies
D. Ratios are immune to seasonality
Answer: C
Explanation: Different accounting choices (FIFO vs. LIFO, straight-line vs. accelerated depreciation) make cross-company ratio comparisons difficult.
Q108.
Under U.S. GAAP, how are interest and dividends classified in the statement of cash flows?
A. Both as operating activities
B. Interest as financing, dividends as investing
C. Interest as operating, dividends as financing
D. Interest as financing, dividends as financing
Answer: C
Explanation: GAAP requires interest paid/received as operating, dividends paid as financing, dividends received as operating. IFRS is more flexible.
Q109.
If a company’s asset turnover ratio increases while profit margin remains constant, ROE will:
A. Increase
B. Decrease
C. Stay constant
D. Cannot be determined
Answer: A
Explanation: ROE (DuPont): ROE = Net margin × Asset turnover × Leverage. Higher asset turnover with stable margin → higher ROE.
Q110.
Which adjustment is necessary when comparing firms that use different inventory methods (FIFO vs. LIFO)?
A. Add LIFO reserve to assets and equity for comparability
B. Subtract LIFO reserve from inventory
C. Add LIFO reserve to liabilities
D. No adjustment required
Answer: A
Explanation: To compare a LIFO firm with FIFO, add LIFO reserve to inventory and equity.
Q111.
Under IFRS, borrowing costs directly attributable to a qualifying asset should be:
A. Expensed immediately
B. Capitalized as part of the asset cost
C. Deducted from equity
D. Treated as financing cash flows
Answer: B
Explanation: IFRS requires capitalization of borrowing costs for qualifying assets (assets that take substantial time to get ready). GAAP also allows capitalization.
Q112.
Which of the following would be classified as an investing activity under U.S. GAAP?
A. Dividends received
B. Purchase of equipment
C. Interest paid
D. Issuance of bonds
Answer: B
Explanation: Investing = acquiring or disposing of long-term assets (e.g., equipment). Dividends received and interest paid are operating under GAAP.
Q113.
Which of the following is considered an aggressive revenue recognition practice?
A. Bill-and-hold sales
B. Percentage-of-completion method
C. Installment sales method
D. Completed contract method
Answer: A
Explanation: Bill-and-hold sales (recognizing revenue before delivery) are often aggressive and risky. Percentage-of-completion is acceptable if reliable.
Q114.
Which of the following is true about goodwill under IFRS?
A. Goodwill is amortized annually
B. Goodwill is tested for impairment only when indicators exist
C. Goodwill can be revalued upwards
D. Goodwill is tested annually for impairment
Answer: D
Explanation: Goodwill is not amortized under IFRS/GAAP; it must be tested annually for impairment.
Q115.
Deferred tax liabilities (DTL) are most likely created when:
A. Tax depreciation > Accounting depreciation
B. Tax revenue > Accounting revenue
C. Tax expense < Accounting expense
D. Carryforward losses exist
Answer: A
Explanation: Higher tax depreciation reduces taxable income → lower taxes now, but higher taxes later → deferred tax liability.
Q116.
Which of the following statements about revaluation under IFRS is correct?
A. Upward revaluations are recorded in income statement
B. Upward revaluations go to equity (revaluation surplus)
C. Revaluation is not permitted under IFRS
D. Revaluation is mandatory under IFRS
Answer: B
Explanation: IFRS allows revaluation of PPE; upward revaluation is recognized in equity, unless reversing prior losses. GAAP prohibits revaluation.
Q117.
A company changes its depreciation method from straight-line to double-declining balance. This is treated as:
A. Change in accounting policy, retrospective
B. Change in estimate, prospective
C. Prior-period adjustment
D. Error correction
Answer: B
Explanation: Change in depreciation method is a change in accounting estimate, applied prospectively (future periods only).
Q118.
Which measure best assesses a company’s liquidity position?
A. Debt-to-equity ratio
B. Current ratio
C. Interest coverage ratio
D. Return on assets
Answer: B
Explanation: Liquidity = ability to meet short-term obligations. Current ratio (CA/CL) is primary measure.
Q119.
Under IFRS, research costs are:
A. Capitalized if future benefits are probable
B. Expensed as incurred
C. Added to goodwill
D. Deferred and amortized
Answer: B
Explanation: Research costs must be expensed. Development costs may be capitalized if conditions are met.
Q120.
Which of the following increases equity?
A. Payment of dividends
B. Issuance of new shares
C. Recording of impairment loss
D. Treasury stock purchase
Answer: B
Explanation: Issuance of shares increases equity. Dividends and treasury purchases reduce equity. Impairments lower retained earnings.
Q121.
A firm with rising prices and inventory levels will report the lowest tax liability using:
A. FIFO
B. Weighted average
C. LIFO
D. Specific identification
Answer: C
Explanation: LIFO results in higher COGS, lower income, and lower taxes in inflationary environment.
Q122.
Which ratio is least useful in analyzing solvency?
A. Debt-to-equity ratio
B. Times interest earned
C. Current ratio
D. Debt ratio
Answer: C
Explanation: Solvency = long-term financial risk. Current ratio is a liquidity ratio, not solvency.
Q123.
Which of the following is a limitation of the indirect method of cash flow reporting?
A. It is not permitted by IFRS
B. It does not separate investing activities
C. It does not show actual sources of operating cash flows
D. It is less accurate
Answer: C
Explanation: Indirect method adjusts net income, so exact operating inflows/outflows are hidden compared to direct method.
Q124.
Which of the following adjustments is necessary for common-size financial statement analysis?
A. Convert balance sheet items to % of revenue
B. Convert income statement items to % of total assets
C. Convert income statement items to % of revenue
D. Convert balance sheet items to % of net income
Answer: C
Explanation: Common-size income statement → % of revenue. Common-size balance sheet → % of total assets.
Q125.
Under IFRS, if fair value of a financial asset increases, unrealized gains are most likely:
A. Recorded in equity (OCI) if asset is FVOCI
B. Recorded in retained earnings directly
C. Ignored until realized
D. Always recorded in income statement
Answer: A
Explanation: IFRS requires FVOCI instruments to report unrealized gains/losses in other comprehensive income.
Q126.
Which accounting treatment is more conservative?
A. Capitalizing R&D costs
B. Expensing development costs immediately
C. Delaying expense recognition
D. Recording lower COGS under FIFO
Answer: B
Explanation: Expensing immediately reduces current earnings and is more conservative.
Q127.
Which of the following transactions affects both cash flow and net income?
A. Depreciation expense
B. Sale of equipment at a gain
C. Issuance of equity
D. Amortization of goodwill
Answer: B
Explanation: Sale of equipment impacts cash inflow and gain/loss impacts income. Depreciation and amortization are non-cash. Equity issuance doesn’t affect income.
Q128.
When analyzing financial statements of a foreign subsidiary, which translation method is used if functional currency = local currency?
A. Temporal method
B. Current rate method
C. FIFO method
D. Equity method
Answer: B
Explanation: If functional currency is local, use current rate method (assets/liabilities at current rate; equity at historical). Temporal method is used if functional currency = parent’s.
Q129.
Which of the following decreases both net income and equity?
A. Depreciation
B. Inventory write-down
C. Treasury stock sale
D. Issuance of bonds
Answer: B
Explanation: Inventory write-down reduces net income and equity. Depreciation reduces income but doesn’t directly reduce equity until closing. Treasury stock sale increases equity.
Q130.
Which of the following is a red flag of earnings manipulation?
A. Rising DSO with stable sales
B. Declining inventory turnover
C. Frequent changes in accounting estimates
D. All of the above
Answer: D
Explanation: All three indicate possible earnings management: longer collection times, slow inventory turnover, and accounting policy changes.
Q131.
Which of the following is most likely a temporary difference leading to deferred taxes?
A. Goodwill amortization
B. Depreciation methods (tax vs. accounting)
C. Permanent tax-exempt income
D. Dividends paid
Answer: B
Explanation: Depreciation differences reverse over time → temporary difference. Tax-exempt income = permanent difference.
Q132.
A company issues bonds at a discount. Over time, the carrying value of the bond:
A. Decreases toward face value
B. Increases toward face value
C. Remains constant
D. Equals zero at maturity
Answer: B
Explanation: Discount amortization increases bond liability until it equals face value at maturity.
Q133.
Which method is least aggressive in inventory valuation during inflation?
A. LIFO
B. FIFO
C. Weighted average
D. Specific identification
Answer: B
Explanation: FIFO reports lower COGS and higher profit in inflation → less conservative (more aggressive). LIFO is more conservative.
Q134.
If a company capitalizes interest cost, compared to expensing, which of the following occurs initially?
A. Higher net income, lower CFO
B. Lower net income, higher CFO
C. No effect on net income
D. Lower assets
Answer: A
Explanation: Capitalizing increases income (interest not expensed) but reduces CFO (interest paid classified as financing).
Q135.
Which of the following best measures profitability relative to assets used?
A. Gross profit margin
B. Return on equity
C. Return on assets
D. Net profit margin
Answer: C
Explanation: ROA = Net income / Total assets → shows profit relative to resources employed.
Q136.
A company uses straight-line depreciation under GAAP. Switching to units-of-production would:
A. Lower early depreciation, raise later
B. Match depreciation to usage
C. Have no effect on earnings
D. Increase asset value
Answer: B
Explanation: Units-of-production ties depreciation to usage, not time, so it better matches asset consumption.
Q137.
Under IFRS, an investment property may be measured at:
A. Cost model only
B. Fair value model only
C. Either cost model or fair value model
D. Revaluation surplus only
Answer: C
Explanation: IFRS allows cost or fair value models for investment property. GAAP allows only cost (no fair value).
Q138.
When analyzing the quality of earnings, which adjustment is least appropriate?
A. Removing one-time gains
B. Adding back restructuring charges
C. Normalizing unusual losses
D. Excluding recurring R&D expense
Answer: D
Explanation: R&D is recurring and should not be excluded; one-time items should be adjusted.
Q139.
A firm with increasing accounts receivable turnover and stable sales likely indicates:
A. Better credit policy enforcement
B. Weak collection efforts
C. Aggressive revenue recognition
D. Seasonal fluctuations
Answer: A
Explanation: Higher receivable turnover means faster collections → improved credit enforcement.
Q140.
If a company reports high earnings but low CFO, this may suggest:
A. Conservative accounting
B. Aggressive revenue recognition
C. Strong solvency
D. Better liquidity
Answer: B
Explanation: Large gap between earnings and cash flow signals aggressive revenue recognition or poor quality earnings.
Q141.
Which of the following statements about OCI (Other Comprehensive Income) is correct?
A. It includes all realized gains/losses
B. It is part of net income
C. It includes unrealized gains on FVOCI securities
D. It is not reported in financial statements
Answer: C
Explanation: OCI includes unrealized gains/losses from FVOCI securities, FX translation, pension remeasurements, etc.
Q142.
Which of the following would most likely increase equity?
A. FX translation gain
B. Treasury stock repurchase
C. Dividend declaration
D. Impairment of PPE
Answer: A
Explanation: FX translation gains go to OCI → equity increase. Treasury repurchase and dividends reduce equity.
Q143.
Which accounting choice would make earnings appear smoother?
A. Accelerated depreciation
B. Straight-line depreciation
C. Expensing development costs immediately
D. LIFO in rising prices
Answer: B
Explanation: Straight-line spreads expenses evenly, smoothing earnings.
Q144.
Which of the following is a cash flow from financing activity?
A. Proceeds from bond issuance
B. Sale of equipment
C. Interest received
D. Dividend income
Answer: A
Explanation: Financing = raising/repaying capital (debt/equity). Sale of equipment = investing. Interest/dividends = operating (GAAP).
Q145.
A firm revalues upward its land under IFRS. This will:
A. Increase net income
B. Increase equity via revaluation surplus
C. Decrease equity
D. No effect on financial statements
Answer: B
Explanation: Upward revaluation increases revaluation surplus in equity, not income.
Q146.
Which of the following is a limitation of ratio analysis?
A. Ratios do not capture qualitative factors
B. Ratios can be compared across industries
C. Ratios are always consistent across firms
D. Ratios predict bankruptcy
Answer: A
Explanation: Ratios ignore qualitative aspects (management quality, market risks).
Q147.
Which of the following most directly measures financial leverage?
A. ROA
B. Debt-to-equity ratio
C. Current ratio
D. Net margin
Answer: B
Explanation: Debt-to-equity directly shows the proportion of debt financing.
Q148.
Which of the following would NOT be considered aggressive accounting?
A. Channel stuffing
B. Delaying impairment recognition
C. Using straight-line depreciation
D. Recognizing revenue before delivery
Answer: C
Explanation: Straight-line depreciation is conservative and smooth. Others are aggressive.
Q149.
A company reports interest paid in financing activities under IFRS. Under GAAP, the same item would appear in:
A. Investing
B. Financing
C. Operating
D. Non-cash section
Answer: C
Explanation: IFRS allows flexibility (operating or financing). GAAP requires interest paid in operating cash flows.
Q150.
Which of the following best describes the effect of capitalizing vs. expensing costs?
A. Capitalizing → higher assets, higher income initially
B. Expensing → higher assets, higher income initially
C. Expensing → lower income, higher equity
D. Capitalizing → lower assets, lower income initially
Answer: A
Explanation: Capitalization defers expense recognition, leading to higher current income and assets, but lower future income.
That concludes CFA Level I FRA Part 3 (Q101–150). ✅ Continue building your knowledge by exploring the next set of questions:
- 🔗 CFA Level I FRA Part 1 (Q1–50)
- 🔗 CFA Level I FRA Part 2 (Q51–100)
- 🔗 CFA Level I FRA Part 4 (Q151–200)
Stay consistent in practice and maximize your chances of success in the CFA Level I exam.