2012 Sample Entrance Examination (Time Allowed: hours) Notes: i) All answers must be indicated on the multiple-choice answer sheet Work done on the question paper and examination foolscap will NOT be marked ii) Included in the examination envelope is a supplement consisting of formulae and tables It is a standard supplement that may be useful for answering questions on this paper iii) Examination materials must NOT BE REMOVED from the examination writing centre All examination materials (i.e answer sheet, used and unused foolscap sheets, envelope, supplement and question paper) must be submitted to the presiding officer before you leave the examination room Revised April 23, 2012 © 2012 The Society of Management Accountants of Canada All rights reserved ®/™ Registered Trade-Marks/Trade-Marks are owned by The Society of Management Accountants of Canada No part of this document may be reproduced in any form without the permission of the copyright holder 2012 Sample Entrance Examination TABLE OF CONTENTS Examination: Instructions Questions Solutions 37 Supplement of Formulae 71 * This supplement is provided to all candidates with the examination 2012 Sample Entrance Examination INSTRUCTIONS: Use the multiple-choice answer sheet provided to record your answers to the questions Be sure to enter your four-digit envelope number on the multiple-choice answer sheet Select the BEST answer for each of the following 100 questions and record your answer on the multiple-choice answer sheet by blackening the appropriate answer space (i.e oval) with a soft lead (HB) pencil Answer all questions Mark ONLY ONE ANSWER for each question Sample Question: 89 (-) Market research and public relations costs are a) b) c) d) engineered variable costs discretionary variable costs committed fixed costs discretionary fixed costs Assuming you select choice d) for your answer, you should blacken the “d” space on line 89 in the “ANSWERS” area of the multiple-choice answer sheet as shown below: 89 a b c d Question Weighting: Your performance will be based on the total weighted value of the questions answered correctly Note that all questions are assigned the same weight, except for those specified with a plus (+) sign (i.e has a higher weight) or minus (-) sign (i.e has a lower weight) In the above example, there is a minus sign at the beginning of the question, signifying that the question has a lower weighted value than the average question Singular Versus Plural Phrasing: For simplicity of wording, all questions are phrased as though there is a single correct answer, even when there are multiple correct answers For example, the correct answer to a question that is worded, “Which of the following is ,” may be the choice that refers to two or more of the other choices, e.g “Both a) and b) above.” CMA Canada Page 2012 Sample Entrance Examination Calculator Policy and Supplement The following models of calculators are authorized for use on the Entrance Examination: Texas Instruments Hewlett Packard Sharp TI BA II Plus (including the Professional model) HP 10bII (or HP 10Bii) EL-738C (EL-738) The supplement accompanying the Entrance Examination contains present value tables CMA Canada Page 2012 Sample Entrance Examination Corporate Finance QWC Ltd has cash of $100,000 that will be invested in an equity investment that has a beta of 2.25 The current risk-free rate in the market is 2.5%, and the market requires an 8% risk premium for equity securities What return should QWC Ltd expect to earn? a) $8,000 b) $18,000 c) $23,625 d) $20,500 (+) BG Corporation is considering a bid to take over SM Limited Should the takeover occur, BG Corporation would benefit from SM Limited’s before-tax operating cash flows of: i) $500,000 per year for the first three years, ii) $700,000 per year from the fourth year into perpetuity, and iii) $225,000 per year of synergistic savings before taxes in perpetuity starting from the first year Assume that the cash flows occur at the end of each year, the tax rate is 40% for both companies, and BG Corporation’s after-tax required rate of return is 13% What is the maximum amount that BG Corporation should be willing to pay to take over SM Corporation (rounded to the nearest thousand dollars)? a) b) c) d) $4,978,000 $2,947,000 $1,909,000 $3,986,000 XYZ company recently issued rights to raise financing The shares are currently trading for $18 per share on the stock exchange The subscription price for the rights offering is $14 per share, and an investor will require rights to purchase share The value of one right is a) $12.00 b) $2.33 c) $1.00 d) $0 CMA Canada Page 2012 Sample Entrance Examination LPY Ltd has cash of $500,000 that will be used to create an investment portfolio The portfolio will be invested evenly in two assets: an equity investment that has a beta of 1.70 and a one-year risk-free interest bearing certificate The current risk-free rate in the market is 3% and the market requires a 6% risk premium for equity securities What one-year return should LPY Ltd expect to earn on its portfolio? a) $7,500 b) $30,000 c) $33,000 d) $40,500 Actual and projected sales of a company for May and June are as follows: May (actual) June (projected) Cash Sales $185,000 $225,000 Credit Sales $270,000 $290,000 All credit sales are collected in the month following the month in which the sale is made The cash balance as at May 31 is $50,000 Cash disbursements for operating expenses in June are projected to be $350,000 The company plans to declare a $50,000 cash dividend on June 30 but will not pay it until 30 days later A $160,000 down payment on a piece of equipment will be made in June To ensure a $60,000 cash balance on June 30, what amount should the company plan to borrow in June? a) $295,000 b) $250,000 c) $75,000 d) $25,000 According to the Efficient Market Hypothesis, what effect would a higher-thanexpected earnings report have on a firm’s share price? a) A gradual increase in the share price over several days b) An immediate decrease in the share price, with no later adjustments c) An immediate increase in the share price, followed by a decrease the following day d) An immediate increase in the share price, with no later adjustments CMA Canada Page 2012 Sample Entrance Examination A company is considering the following projects: Annual after-tax cash inflows Initial project cost Cost of capital Project life W $620,000 $2,000,000 9% years X $1,000,000 $5,000,000 11% years Y $2,000,000 $10,000,000 13% years Based only on profitability index, which project(s) should the company invest in? a) b) c) d) Only W Only X Only Y All three projects The Capital Asset Pricing Model (CAPM) disregards diversifiable risk because the model a) assumes that investors are risk neutral but not risk averse b) assumes that investors will be holding anywhere from one security to the entire market of securities c) assumes that diversifiable risk represents that aspect of financial risk which is unique to that security and not related to the financial risk of the market d) recognizes that diversifiable risk can be virtually eliminated with a large enough portfolio (+) On January 1, 2007, Moon Co issued eight-year bonds with a face value of $950,000 and a stated interest rate of 7%, payable semi-annually on June 30 and December 31 The market yield for similar bonds was 8% Two years later, on January 1, 2009, Moon Co repurchased the bonds in the open market to reduce its overall level of debt At the date of repurchase, the market yield had increased to 10% What is the difference in cash received at issuance and cash paid at repurchase for the bond (rounded to the nearest thousand)? a) $(11,000) b) $126,000 c) $0 d) $71,000 10 (-) An asset’s market (systematic) risk is measured by its a) b) c) d) CMA Canada variance of returns beta coefficient standard deviation total return Page 2012 Sample Entrance Examination 11 (+) Assume that Acquire Ltd wants to raise capital by issuing a $48,000,000 mortgage bond A brokerage firm that raises market capital for Acquire Ltd estimates that the 10-year bond will need a stated annual interest rate of 8.0% Semi-annual interest payments are made on January 31 and July 31 each year The brokerage firm also charges 2.5% of face value for commission and administration charges This bond is sold to the primary market on February with an effective interest rate of 10.0% How much cash will Acquire Ltd receive from the sale of this mortgage bond (rounded to the nearest ten thousand)? a) b) c) d) 12 $42,020,000 $42,120,000 $40,820,000 $41,070,000 DHC Ltd is looking to purchase WIC Ltd., which has the following information: Revenue EBITD Basic EPS Net assets Shares outstanding Dividends paid $4,000,000 $900,000 $1.40 $5,000,000 500,000 $0.50 Research has shown that the price-earnings ratio for companies like WIC Ltd is 9.5 Based on that ratio, what is the value of WIC Ltd.? a) b) c) d) 13 $2,375,000 $8,550,000 $5,000,000 $6,650,000 (+) XYZ Ltd has the following current and projected information: Sales Variable costs (35% of sales) Fixed costs (excluding interest and taxes) Earnings per share Current $700,000 $245,000 $120,000 $0.90 Projected $800,000 $280,000 $120,000 $1.00 Given the above information, what is the projected degree of operating leverage for XYZ Ltd.? a) b) c) d) CMA Canada 0.78 0.57 0.74 1.36 Page 2012 Sample Entrance Examination 14 (+) Trout Ltd produces a single product that has a contribution margin of 60% per unit and sold 500,000 units last year Trout has a degree of operating leverage of 1.60 and a degree of financial leverage of 1.20 for the current year If the sales volume were to increase by 10% this coming year, what would be the expected percentage increase in earnings per share (rounded to the nearest percent)? a) 16% b) 12% c) 6% d) 19% 15 (+) A company is looking to replace a machine with a new unit that is more efficient The old machine is also in need of many repairs Purchase price Salvage value today Salvage value in years Repairs immediately Repairs at the end of years Annual operating costs Remaining life Old Machine $100,000 $15,000 $1,000 $25,000 $10,000 $20,000 years New Machine $120,000 n/a $80,000 n/a n/a $12,000 years Based on a cost of capital of 7% and ignoring tax effects, what is the net present value in favour of buying the new machine? a) $17,287 b) $(2,287) c) $(15,513) d) $49,000 16 (+) SCC Inc has the following financial information: Current liabilities Long-term debt Total liabilities Preferred shares Common equity $900,000 $1,300,000 $2,200,000 $3,500,000 $6,200,000 The long-term debt consists of a single bond issue paying 6% interest annually These bonds currently yield 7.5% in the market The current cost of the preferred shares is 8% The current cost of the common shares is 12% The company’s tax rate is 40% What is SCC Inc.’s weighted average cost of capital (rounded to the nearest tenth of a percent)? a) 9.4% b) 10.2% c) 9.8% d) 9.2% CMA Canada Page 2012 Sample Entrance Examination 17 Flower Inc is issuing preferred shares to raise capital Each preferred share will be issued with a par value of $200 and a cumulative dividend of $18 The preferred shares will result in after-tax underwriting expenses of $3 per share What is the cost of issuing the preferred shares? a) 9.14% b) 9.00% c) 7.50% d) 10.50% 18 RLC Ltd is considering investing into one of the following: i) Investment A at 9.75% compounded monthly ii) Investment B at 9.25% compounded daily iii) Investment C at 10.0% compounded quarterly Which investment(s) should the company choose? a) b) c) d) Only A Only B Only C Either A or B Financial Accounting 19 DLC Ltd has calculated its basic EPS to be $5.50 at the end of Year and has the following outstanding debt and equity information i) $2,000,000 in 10% convertible bonds Each $1,000 bond could be converted to common shares ii) 5,000 outstanding stock options awarded at the start of Year to executives at DLC with an exercise price of $55 The price of DLC stock reached $58 on July 1, Year iii) 50,000 convertible preferred shares issued at the start of Year 4, each with a $50 annual cumulative dividend paid at the end of each year Each preferred share could be converted to 10 common shares The corporate tax rate is 40% Which of the above items could dilute the basic EPS? a) b) c) d) CMA Canada i) only iii) only ii) and iii) only All of i), ii) and iii) Page 2012 Sample Entrance Examination 73 Answer: d If lower-grade materials resulted in excessive waste, then more materials were used than anticipated But materials purchased at a discount would explain a favourable price variance Choice a) This would result in both a favourable price and quantity variance Choice b) This would result in a favourable price variance, but would not explain an unfavourable quantity variance Choice c) The price variance relates to price paid and the quantity variance to quantity used; hence this information is insufficient to determine the impact on these variances 74 Answer: c Activity-based costing attempts to allocate overhead based on the estimated use of resources, so more overhead is allocated to low-volume products using activity-based costing Traditional costing approaches use volume bases such as direct labour hours or machine-hours to allocate overhead to product costs; hence more overhead is allocated to high-volume products using traditional costing Choice a) Activity-based costing attempts to allocate overhead based on the estimated use of resources Manufacturing overhead that is considered to be organization-sustaining in nature would not be allocated to product cost under the activity-based approach Choice b) Activity-based costing is not acceptable for external financial reporting Choice d) Traditional costing allocates more overhead to high-volume products 75 Answer: c Contribution margin per unit Fixed costs Breakeven sales = $80 - ($13 + $12 + $5) - $80x5% = ($20 x 60,000 x 80% + $420,000) = $1,380,000 / $46 = $46 = $1,380,000 = 30,000 units Choice a) Incorrectly uses gross profit in computing breakeven sales Gross profit per unit = $80 - ($13 + $12 + $5 + $10) = $40 Fixed costs = ($20 x 60,000 x 80% + $420,000) = $1,380,000 Breakeven sales = $1,380,000 / $40 = 34,500 units Choice b) Includes fixed overhead in contribution margin Contribution margin per unit = $46 - $10 = $36 Fixed costs = ($20 x 60,000 x 80% + $420,000) = $1,380,000 Breakeven sales = $1,380,000 / $36 = 38,334 units Choice d) Misses fixed overhead Contribution margin per unit = $80 - ($13 + $12 + $5) - $80 x 5% = $46 Breakeven sales = $420,000 / $46 = 9,131 units CMA Canada Page 60 2012 Sample Entrance Examination 76 Answer: d With CP5 Selling price $80 Direct materials 13 Direct labour 12 Variable overhead (0.5 MCH x 80% x $10 per MCH) Variable selling costs ($80 x 5%) Total variable costs 34 Contribution margin per unit $46 Total contribution margin (99,000/110% x $46); (99,000 x $45) $4,140,000 Increase in income = $4,455,000 - $4,140,000 = $315,000 With CP8 $80 15 12 4 35 $45 $4,455,000 Choice a) Incorrectly uses gross profits With CP5 $80 13 12 10 40 $40 Selling price Direct materials Direct labour Variable overhead (0.5 MCH x 80% x $10 per MCH) Fixed overhead (0.5 MCH x 80% x $20 per MCH) Product cost per unit Gross profits per unit Total gross profits (99,000/110% x $40); (99,000 x $45) $3,600,000 Decrease in income = $4,059,000 - $3,600,000 = $531,000 With CP8 $80 15 12 39 $41 $4,059,000 Choice b) Incorrectly uses gross profits times the number of units Increase in income = ($41 - $40) x 99,000 units = $99,000 Choice c) Incorrectly uses difference in number of units times sales price [99,000 - (99,000/110%)] x $80 = $720,000 CMA Canada Page 61 2012 Sample Entrance Examination 77 Answer: c Difference in income = (8,700 - 8,400) x $10 = $3,000 Absorption costing income is $3,000 lower than direct costing income because 300 more units were sold than produced, i.e a decrease in 300 units of inventory, since more fixed overhead in beginning inventory is deducted as cost of goods sold under absorption costing, or: Absorption Costing Income Sales ($80 x 8,700) Cost of goods sold Standard cost of goods sold ($40 x 8,700) Production volume variance ($20 x 60,000 x 80%/12 - $10 x 8,400) Adjusted cost of goods sold Gross profits Selling and administrative expenses ($80 x 5% x 8,700 + $420,000/12) Operating Income Direct Costing Income Sales Variable costs Variable cost of goods sold ($30 x 8,700) Variable S&A expenses ($80 x 5% x 8,700) Total variable costs Contribution margin Fixed costs ($20 x 60,000 x 80%/12 + $420,000/12) Operating Income $696,000 348,000 (4,000) 344,000 352,000 69,800 $282,200 $696,000 261,000 34,800 295,800 400,200 115,000 $285,200 Choice a) Mistakes the difference as higher under absorption costing Choice b) Incorrectly uses variable overhead and mistakes the difference as higher under absorption costing Choice d) Incorrectly uses variable overhead CMA Canada Page 62 2012 Sample Entrance Examination 78 Answer: b Direct labour hours requirement at maximum demand: Cutting = 10/60 x 2,500 x months + 20/60 x 1,500 x months = 2,750 DLH Finishing = 15/60 x 2,500 x months + 40/60 x 1,500 x months = 4,875 DLH Thus, production constraint exists for hours in Finishing department Contribution margin per unit: Wallets = $30 - $8 - $2 = $20 Belts = $50 - $15 - $3 = $32 Contribution margin per direct labour hour (Finishing): Wallets = $20 / (15/60) = $80 per DLH (Finishing) Belts = $32 / (40/60) = $48 per DLH (Finishing) Thus, in addition to meeting the contract requirement for 1,800 belts, ALC should use capacity to manufacture wallets first and then belts as follows: Production Plan Direct Labour Hours (Finishing) Required Belts 1,800 units 1,800 x 40/60 = 1,200 DLH Wallets 7,500 units 7,500 x 15/60 = 1,875 DLH Belts 525 / (40/60) = 787.5 units 3,600 - 1,200 - 1,875 = 525 DLH ALC should produce 7,500 wallets and 2,587 belts to maximize its profits Choice a) Does not use excess capacity of 525 DLH Choice c) Assumes production matches maximum sales volume and ignores constraints Choice d) Incorrectly uses net margin instead of contribution margin Net margin per unit: Wallets = $30 - $8 - $2 - $5 - $6 = $9 per unit Belts = $50 - $15 - $3 - $5 - $1 = $26 per unit Net margin per direct labour hour (Finishing): Wallets = $9 / (15/60) = $36 per direct labour hour (Finishing) Belts = $26 / (40/60) = $39 per direct labour hour (Finishing) In this case, ALC should use the capacity to product belts first and then wallets Production Plan Direct Labour Hours (Finishing) Required Belts 4,500 units 4,500 x 40/60 = 3,000 DLH Wallets 600 / (15/60) = 2,400 units 3,600 DLH - 3,000 DLH = 600 DLH That is, ALC will produce 2,400 wallets and 4,500 belts CMA Canada Page 63 2012 Sample Entrance Examination 79 Answer: d Total fixed costs: [$20(5,000 + 10,000 + 20,000)] + $500,000 = $1,200,000 Contribution margin per unit: A = $400 - ($100 + $50 + $60) = $190 B = $250 - ($80 + $50 + $40) = $80 C = $150 - ($40 + $50 + $10) = $50 Weighted average contribution margin per unit: [($190 x 1) + ($80 x 2) + ($50 x 4)]/(1 + + 4) = ($190 + $160 + $200)/7 = $550/7 = $78.57 Breakeven volume = $1,200,000/$78.57 = 15,270 (rounded) Choice a) Uses gross margin per unit: $500,000/{[($170 x 1) + ($60 x 2) + ($30 x 4)]/7} = $500,000/($410/7) = 8,540 Choice b) Uses mix of 1:1:1: $1,200,000/[($190 + $80 + $50)/3] = $1,200,000/($320/3) = 11,250 Choice c) Uses variable cost per unit: $1,200,000/{[($210 x 1) + ($170 x 2) + ($100 x 4)]/7} = $1,200,000/($950/7) = 8,840 CMA Canada Page 64 2012 Sample Entrance Examination 80 Answer: a Product Sales price Less variable costs: Materials Labour Manufacturing overhead (1) Contribution margin per unit (2) Direct material cost per unit (3) Direct material cost per gram (4) Direct material grams required per unit (2) ÷ (3) Contribution margin per gram of material (1) ÷ (4) A $120 B $180 C $ 190 (24) (54) (6) 36 24 16 1.5 $ 24 (64) (28) (16) 72 64 16 4.0 $ 18 (32) (110) (8) 40 32 16 2.0 $ 20 Choice b) Incorrectly ranks based on contribution margin per unit: A B C Sales price $120 $180 $ 190 Less variable costs: Materials (24) (64) (32) Labour (54) (28) (110) Manufacturing overhead (6) (16) (8) Contribution Margin per Unit $ 36 Choice c) Incorrectly calculates margin: Product Sales price Less variable costs: Materials Labour Manufacturing overhead (1) Contribution margin per unit (2) Direct material cost per unit (3) Margin per dollar of material (1) ÷ (2) Choice d) Incorrectly includes fixed overhead: Product A Sales price $120 Less costs: Materials (24) Labour (54) Manufacturing overhead (6) Fixed overhead (1) Contribution Margin per Unit CMA Canada $ 35 $ 72 $ 40 A $120 B $180 C $ 190 (24) (54) (6) 36 24 1.5 (64) (28) (16) 72 64 4.5 (32) (110) (8) 40 32 1.25 B $180 C $ 190 (64) (28) (16) (38) (32) (110) (8) (7) $ 34 $ 33 Page 65 2012 Sample Entrance Examination 81 Answer: d Production resources include direct materials, direct labour and other manufacturing overhead Thus, units of output per dollar of production resources is a total factor productivity measure Choice a) Return on investment is computed as the ratio of income to assets Assets are the inputs used to generate income, a comprehensive output measure Return on investment is a productivity measure Choice b) Salespersons, the input, are directly involved in generating sales revenue, the output Revenue per salesperson is a partial factor productivity measure Choice c) Units of output per direct labour hour is a partial factor productivity measure 82 Answer: b Sales mix variance = (9,200/16,000 - 10,000/15,000) x 16,000 x ($8.00 - $1.60 - $1.40) + (6,800/16,000 - 5,000/15,000) x 16,000 x ($5.00 - $0.75 - $0.65) = $2,053.33 (U) Market share variance = $4.5333* x 100K x (16,000/100,000 - 20%) = $18,133.33 (U) Market size variance = $4.5333* x (100K - 15,000/0.20) x 20% = $22,666.67 (F) * Total budgeted contribution margin / total budgeted units Choice a) Misinterprets both market share and market size variances Choice c) Misinterprets both market share and total sales mix variances Choice d) Misinterprets total sales mix variances 83 Answer: b Sales volume variance should be computed based on budgeted contribution margin per unit: ($8.00 - $1.60 - $1.40) = $5.00 per unit Sales volume variance = (9,200 - 10,000) x ($8.00 - $1.60 - $1.40) = $4,000 (U) Choice a) Incorrectly uses budgeted gross profit per unit = (9,200 - 10,000) x ($8.00 - $1.60 - $1.20) = $4,160 unfavourable Choice c) Incorrectly uses actual gross profit per unit = (9,200 - 10,000) x ($7.50 - $1.50 - $1.25) = $3,800 unfavourable Choice d) Incorrectly uses actual contribution margin per unit = (9,200 - 10,000) x ($7.50 - $1.50 - $1.50) = $3,600 unfavourable 84 Answer: d Total sales quantity variance = 10,000/15,000 x (16,000 - 15,000) x ($8.00 - $1.60 $1.40) + 5,000/15,000 x (16,000 - 15,000) x ($5.00 - $0.75 - $0.65) = $4,533.33 (F) Choice a) Incorrectly calculates total selling price variance ($7.50 - $8.00) x 9,200 + ($5.50 - $5.00) x 6,800 = $1,200 (U) Choice b) Incorrectly calculates total sales volume variance (9,200 - 10,000) x ($8.00 - $1.60 - $1.40) + (6,800 - 5,000) x ($5.00 - $0.75 - $0.65) = $2,480 (F) Choice c) Incorrectly calculates total sales mix variance (9,200/16,000 - 10,000/15,000) x 16,000 x ($8.00 - $1.60 - $1.40) + (6,800/16,000 - 5,000/15,000) x 16,000 x ($5.00 - $0.75 - $0.65) = $2,053.33 (U) CMA Canada Page 66 2012 Sample Entrance Examination 85 Answer: a Gross salary $100,000 + Spouse’s travel $3,000 + Gift cards (near cash) $500 = $103,500 Choice b) $105,000 = Gross salary + Vacation owed Choice c) $107,000 = Gross salary + Discounts $3,500 + Spouse’s travel $3,000 + Gift cards (near cash) $500 Choice d) $108,500 = Gross salary + Vacation pay + Either discounts or [Spouse’s travel + Gift cards] 86 Answer: d Unincorporated businesses, like sole proprietorships, are not taxable entities Income earned by the proprietorship is taxed in the hands of the proprietor (i.e owner) Choices a) to c) are all considered taxable entities 87 Answer: b UCC Disposition Balance $100,000 $(110,000) (Lower of original cost or proceeds) $(10,000) = Recapture of $10,000 Choice a) Uses original cost to calculate: $100K - $140K = $40K Choice c) Uses proceeds less selling fees: $100K - ($110K - $5K) = $5K Choice d) Calculates as a terminal loss: $140K - $110K = $30K 88 Answer: a This is a terminal loss and, as it is a rental property costing more than $50,000, it is in a separate class and the loss must be taken into income in the year of disposition Choice b) This is not an option; as it is a rental property costing more than $50,000, it is in a separate class and therefore the CCA must be taken into income Choice c) This is not an option for this type of property that is sold Choice d) This is not an option 89 Answer: c 650,000 + 90,000 + 2,000 + 5,000 - 4,000 = $743,000 Income tax is added back, and accounts payable for charitable donations and investment counsel fees are added back as these expenses are only deductible when paid and the CCA in excess of deprecation is subtracted Choice a) Omits add back of income tax and investment counsel fees (650,000 + 2,000 - 4,000) Choice b) Subtracts rather than adds payables (650,000 + 90,000 - 2,000 - 5,000 - 4,000) Choice d) Also adds back allowances, which is not required (650,000 + 90,000 + 2,000 + 5,000 - 4,000 + 11,000) CMA Canada Page 67 2012 Sample Entrance Examination 90 Answer: a This is a non-arms’-length transaction Shauna would incur an immediate capital gain of $175,000 (proceeds) less $100,000 (ACB) = $75,000 Choice b) Incorrectly assumes fair market value for the transfer Choice c) Incorrectly assumes the difference between proceeds and fair market value Choice d) Assumes capital gain will be with Daniel, the son 91 Answer: b The determination is a question of fact, and the actual terms and conditions of employment are the deciding factor Choice a) Ownership of tools and equipment is a factor that is considered but not the deciding one Choice c) This is not always the case because the determination of the degree of control can be difficult when examining the employment of professionals such as engineers, doctors and IT consultants Because of their expertise and specialized training, they may require little or no specific direction from the payer in their daily activities Choice d) This is a factor that is considered but is only one of several terms and conditions considered 92 Answer: d The floating weighted-average method is used to determine the adjusted cost base (ACB) for identical assets, such as the shares of a particular company The capital gain or loss is calculated by the following formula: proceeds of disposition minus the aggregate of (i) adjusted cost base and (ii) expenses of the disposition ACB = (4,000 x $7.60) + (2,000 x $8.10) / (2,000 + 4,000) = ($30,400 + $16,200) / 6,000 = $7.767 Capital gain = $40,000 - ($7.767 x 5,000) - $400 = $765 = $765 capital gain x 50% = $382.50 ~ $380 taxable capital gain Choice a) Uses FIFO: 4,000 x ($8 - $7.60) + 1,000 x ($8 - $8.10) = $1,500 gain Choice b) Ignores selling expenses: $40,000 - ($7.767 x 5,000) = $1,165 x 50% = $582.50 ~ $580 taxable capital gain Choice c) Neglects the 50% capital gain rule CMA Canada Page 68 2012 Sample Entrance Examination 93 Answer: c Fraud can be perpetrated because there is always a trade-off between the cost and benefits of internal controls For example, collusion between employees and third parties, or management and employees can circumvent normal controls Management override of controls can result in fraudulent financial reporting Choice a) False – The external auditor is primarily interested in controls over financial reporting The internal auditor’s responsibility can include safeguarding of assets, efficiency and effectiveness of operations and compliance with laws and regulations Choice b) False – Well-designed controls are helpful but not ensure that the financial statements will not be materially misstated Choice d) False – Small entities can institute effective controls over many aspects of the business For example, the top level of management (often the owner/manager) can review journal entries, reconcile the bank statement and open all of the mail 94 Answer: c The only control in place to stop this is the customer, and if the customer does not notice, the control will not work Choice a) False – Once the funds are in the cash register and the sale has been recorded, any shortfall of cash can be detected by comparing the cash deposit to the cash register totals Choice b) False – If customers not want a receipt, the employee can take cash before it is recorded by the cash register However, the transaction display on the cash register that the customer sees is one control The other control will be the mismatch between sales recorded in the register and inventory Choice d) False – Taking merchandise does not meet the objective of stealing cash and is more likely to be observed Cash is liquid and easier to hide 95 Answer: c The receiving supervisor has access to the assets and the accounting records She/he could misappropriate inventory and cover it up with false entries to the perpetual inventory records Choice a) The controller would detect unauthorized use or disbursement of cash Choice b) The cashier prepares the bank deposit and the accounting manager reviews it to ensure completeness before it is deposited Choice d) The assistant controller authorizes payment but does not have access to the assets (cash and cheques) 96 Answer: a The principal mechanism for preventing fraud is control Primary responsibility for establishing and maintaining control rests with management Such prevention is ultimately a matter of policies and procedures established by management CMA Canada Page 69 2012 Sample Entrance Examination 97 Answer: a The internal auditors are responsible for examining and evaluating the effectiveness of other functions within the organization These responsibilities include assessing the control systems, identifying areas of risk that need to be addressed in the control system, and making recommendations for improving the internal control process Choice b) The responsibility for monitoring and maintaining internal controls is part of management’s overall responsibility for the ongoing activities of the business—it is not the internal auditor’s responsibility Choice c) The board of directors or the audit committee is responsible for appointing the external auditors, not the internal auditors 98 Answer: c The auditor may rely on the internal auditor without testing the controls However, the external auditor would perform other procedures to assess the reliability of the internal auditor’s tests The nature, timing and extent of other audit procedures would be affected by the decision to rely Choice a) False – Tests of controls are not usually relevant for the audit objectives: valuation, rights and obligations, and presentation and disclosure Choice b) False – The auditor would test only those where there is a risk of material misstatement Choice d) False – The auditor may choose to use only substantive testing but cannot choose to rely solely on tests of controls 99 Answer: d The processes are so integrated in an ERP that they frequently trigger other processes For example, an unauthorized user who accesses the purchasing module could trigger both the purchase of goods and the payment for those goods Choice a) False – The ERP system is so interconnected that there are more areas for private and confidential information to be available Applications that could be separately maintained in a legacy system may be integrated in the ERP Choice b) False – The danger in using complex passwords that change frequently is that employees cannot remember them, so they write them down in a location nearby and accessible to others Choice c) False – While the integration in the ERP may result in the one user having duties that would be considered incompatible in other systems, the focus of supervision moves from the transaction level to overall performance 100 Answer: a The service provider would be responsible for testing all changes in the operating systems and programs The results would then have to be approved by the IT department Choice b) False – Generally, the user departments are not directly involved in the maintenance of operating systems Choice c) False – Parallel runs are typically done with application software, but not with operating systems Choice d) False – Application software would not be the subject of these changes It is the operating software that is maintained by the service provider CMA Canada Page 70 2012 Sample Entrance Examination Supplement of Formulae and Present Value Tables Formulae CAPITAL STRUCTURE a) After-Tax Marginal Cost of Debt: kb = k(1− T) or where b) k = interest rate; T = corporate tax rate; I = annual interest payment on debt; F = face value of debt Cost of Preferred Shares: kp = Dp NPp where c) (1− T)I F Dp = stated annual dividend payment on shares; NPp = net proceeds on preferred share issue Cost of Common Equity: i) Cost of Common Shares (Capitalization of Dividends with Constant Growth Rate): ke = D +g NP e where ii) D1 = dividend expected for period 1; NPe = net proceeds on common share issue; g = annual long-term dividend growth rate Cost of Retained Earnings: kre = re = where CMA Canada D +g P e Pe = market price of a share; re = expected return on common equity Page 71 2012 Sample Entrance Examination iii) Capital Asset Pricing Model: ( Rj = Rf + β j Rm − Rf where d) ) Rj = expected rate of return on security j; Rf = risk-free rate; Rm = expected return for the market portfolio βj = beta coefficient for security j (measure of systematic risk) Weighted Average Cost of Capital: B P E k = kb + kp + ke V V V where B = amount of debt outstanding; P = amount of preferred shares outstanding; E = amount of common equity outstanding V = B + P + E = total value of firm PRESENT VALUE OF TAX SHIELD FOR AMORTIZABLE ASSETS a) Present Value of Total Tax Shield from CCA for a New Asset Present Value = b) CTd + k CdT + 0.5k = (d + k ) 2(1 + k ) (d + k ) + k Present Value of Total Tax Shield from CCA for an Asset that is Not Newly Acquired dT Present Value = UCC d +k c) Present Value of Total Tax Shield Lost From Salvage Present Value = Sn (1 + k )n Sn dT or n −1 d + k (1 + k ) dT , depending on cash flow assumptions d +k Notation for above formulae: C = net initial investment; UCC = undepreciated capital cost of asset; Sn = salvage value of asset realized at end of year n; T = corporate tax rate; k = discount rate or time value of money; d = maximum rate of capital cost allowance; n = total life of investment CMA Canada Page 72 2012 Sample Entrance Examination Table – Present Value of One Dollar Due at the End of n Years P= n 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 1% 0.990 980 971 961 951 942 933 923 914 905 896 887 879 870 861 853 844 836 828 820 811 803 795 788 780 2% 0.980 961 942 924 906 888 871 853 837 820 804 788 773 758 743 728 714 700 686 673 660 647 634 622 610 CMA Canada 3% 0.971 943 915 888 863 837 813 789 766 744 722 701 681 661 642 623 605 587 570 554 538 522 507 492 478 4% 0.962 925 889 855 822 790 760 731 703 676 650 625 601 577 555 534 513 494 475 456 439 422 406 390 375 5% 0.952 907 864 823 784 746 711 677 645 614 585 557 530 505 481 458 436 416 396 377 359 342 326 310 295 6% 0.943 890 840 792 747 705 665 627 592 558 527 497 469 442 417 394 371 350 331 312 294 278 262 247 233 7% 0.935 873 816 763 713 666 623 582 544 508 475 444 415 388 362 339 317 296 277 258 242 226 211 197 184 8% 0.926 857 794 735 681 630 583 540 500 463 429 397 368 340 315 292 270 250 232 215 199 184 170 158 146 9% 0.917 842 772 708 650 596 547 502 460 422 388 356 326 299 275 252 231 212 194 178 164 150 138 126 116 10% 0.909 826 751 683 621 564 513 467 424 386 350 319 290 263 239 218 198 180 164 149 135 123 112 102 092 11% 0.901 812 731 659 593 535 482 434 391 352 317 286 258 232 209 188 170 153 138 124 112 101 091 082 074 12% 0.893 797 712 636 567 507 452 404 361 322 287 257 229 205 183 163 146 130 116 104 093 083 074 066 059 (1+ i) n 13% 0.885 783 693 613 543 480 425 376 333 295 261 231 204 181 160 142 125 111 098 087 077 068 060 053 047 14% 0.877 769 675 592 519 456 400 351 308 270 237 208 182 160 140 123 108 095 083 073 064 056 049 043 038 15% 0.870 756 658 572 497 432 376 327 284 247 215 187 163 141 123 107 093 081 070 061 053 046 040 035 030 16% 0.862 743 641 552 476 410 354 305 263 227 195 168 145 125 108 093 080 069 060 051 044 038 033 028 024 17% 0.855 731 624 534 456 390 333 285 243 208 178 152 130 111 095 081 069 059 051 043 037 032 027 023 020 18% 0.847 718 609 516 437 370 314 266 225 191 162 137 116 099 084 071 060 051 043 037 031 026 022 019 016 19% 0.840 706 593 499 419 352 296 249 209 176 148 124 104 088 074 062 052 044 037 031 026 022 018 015 013 20% 0.833 694 579 482 402 335 279 233 194 162 135 112 093 078 065 054 045 038 031 026 022 018 015 013 010 21% 0.826 683 564 467 386 319 263 218 180 149 123 102 084 069 057 047 039 032 027 022 018 015 012 010 009 22% 0.820 672 551 451 370 303 249 204 167 137 112 092 075 062 051 042 034 028 023 019 015 013 010 008 007 23% 0.813 661 537 437 355 289 235 191 155 126 103 083 068 055 045 036 030 024 020 016 013 011 009 007 006 24% 0.806 650 524 423 341 275 222 179 144 116 094 076 061 049 040 032 026 021 017 014 011 009 007 006 005 25% 0.800 640 512 410 328 262 210 168 134 107 086 069 055 044 035 028 023 018 014 012 009 007 006 005 004 Page 73 2012 Sample Entrance Examination Table – Present Value of One Dollar per Year – n Years at i% 1− 1+ i n ) ( P = n i n 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 1% 0.990 1.970 2.941 3.902 4.854 5.796 6.728 7.652 8.566 9.471 10.368 11.255 12.134 13.004 13.865 14.718 15.562 16.398 17.226 18.046 18.857 19.661 20.456 21.244 22.023 2% 0.980 1.942 2.884 3.808 4.713 5.601 6.472 7.325 8.162 8.983 9.787 10.575 11.348 12.106 12.849 13.578 14.292 14.992 15.678 16.351 17.011 17.658 18.292 18.914 19.523 CMA Canada 3% 0.971 1.914 2.829 3.717 4.580 5.417 6.230 7.020 7.786 8.530 9.253 9.954 10.635 11.296 11.938 12.561 13.166 13.753 14.324 14.877 15.415 15.937 16.444 16.936 17.413 4% 0.962 1.886 2.775 3.630 4.452 5.242 6.002 6.733 7.435 8.111 8.760 9.385 9.986 10.563 11.118 11.652 12.166 12.659 13.134 13.590 14.029 14.451 14.857 15.247 15.622 5% 0.952 1.859 2.723 3.547 4.330 5.076 5.786 6.463 7.108 7.722 8.306 8.863 9.394 9.899 10.380 10.838 11.274 11.690 12.085 12.462 12.821 13.163 13.489 13.799 14.094 6% 0.943 1.833 2.673 3.465 4.212 4.917 5.582 6.210 6.802 7.360 7.887 8.384 8.853 9.295 9.712 10.106 10.477 10.828 11.158 11.470 11.764 12.042 12.303 12.550 12.783 7% 0.935 1.808 2.624 3.387 4.100 4.767 5.389 5.971 6.515 7.024 7.499 7.943 8.358 8.745 9.108 9.447 9.763 10.059 10.336 10.594 10.836 11.061 11.272 11.469 11.654 8% 0.926 1.783 2.577 3.312 3.993 4.623 5.206 5.747 6.247 6.710 7.139 7.536 7.904 8.224 8.560 8.851 9.122 9.372 9.604 9.818 10.017 10.201 10.371 10.529 10.675 9% 0.917 1.759 2.531 3.240 3.890 4.486 5.033 5.535 5.995 6.418 6.805 7.161 7.487 7.786 8.061 8.313 8.544 8.756 8.950 9.129 9.292 9.442 9.580 9.707 9.823 10% 0.909 1.736 2.487 3.170 3.791 4.355 4.868 5.335 5.759 6.145 6.495 6.814 7.103 7.367 7.606 7.824 8.022 8.201 8.365 8.514 8.649 8.772 8.883 8.985 9.077 11% 0.901 1.713 2.444 3.102 3.696 4.231 4.712 5.146 5.537 5.889 6.207 6.492 6.750 6.982 7.191 7.379 7.549 7.702 7.839 7.963 8.075 8.176 8.266 8.348 8.422 12% 0.893 1.690 2.402 3.037 3.605 4.111 4.564 4.968 5.328 5.650 5.938 6.194 6.424 6.628 6.811 6.974 7.120 7.250 7.366 7.469 7.562 7.645 7.718 7.784 7.843 13% 0.885 1.668 2.361 2.975 3.517 3.998 4.423 4.799 5.132 5.426 5.687 5.918 6.122 6.303 6.462 6.604 6.729 6.840 6.938 7.025 7.102 7.170 7.230 7.283 7.330 14% 0.877 1.647 2.322 2.914 3.433 3.889 4.288 4.639 4.946 5.216 5.453 5.660 5.842 6.002 6.142 6.265 6.373 6.467 6.550 6.623 6.687 6.743 6.792 6.835 6.873 15% 0.870 1.626 2.283 2.855 3.352 3.785 4.160 4.487 4.772 5.019 5.234 5.421 5.583 5.725 5.847 5.954 6.047 6.128 6.198 6.259 6.313 6.359 6.399 6.434 6.464 16% 0.862 1.605 2.246 2.798 3.274 3.685 4.039 4.344 4.607 4.833 5.029 5.197 5.342 5.468 5.576 5.669 5.749 5.818 5.878 5.929 5.973 6.011 6.044 6.073 6.097 17% 0.855 1.585 2.210 2.743 3.199 3.589 3.922 4.207 4.451 4.659 4.836 4.988 5.118 5.229 5.324 5.405 5.475 5.534 5.585 5.628 5.665 5.696 5.723 5.747 5.766 18% 0.848 1.566 2.174 2.690 3.127 3.498 3.812 4.078 4.303 4.494 4.656 4.793 4.910 5.008 5.092 5.162 5.222 5.273 5.316 5.353 5.384 5.410 5.432 5.451 5.467 19% 0.840 1.547 2.140 2.639 3.058 3.410 3.706 3.954 4.163 4.339 4.487 4.611 4.715 4.802 4.876 4.938 4.990 5.033 5.070 5.101 5.127 5.149 5.167 5.182 5.195 20% 0.833 1.528 2.107 2.589 2.991 3.326 3.605 3.837 4.031 4.193 4.327 4.439 4.533 4.611 4.676 4.730 4.775 4.812 4.844 4.870 4.891 4.909 4.925 4.937 4.948 21% 0.826 1.510 2.074 2.540 2.926 3.245 3.508 3.726 3.905 4.054 4.177 4.279 4.362 4.432 4.489 4.536 4.576 4.608 4.635 4.657 4.675 4.690 4.703 4.713 4.721 22% 0.820 1.492 2.042 2.494 2.864 3.167 3.416 3.619 3.786 3.923 4.035 4.127 4.203 4.265 4.315 4.357 4.391 4.419 4.442 4.460 4.476 4.488 4.499 4.507 4.514 23% 0.813 1.474 2.011 2.448 2.804 3.092 3.327 3.518 3.673 3.799 3.902 3.985 4.053 4.108 4.153 4.189 4.219 4.243 4.263 4.279 4.292 4.302 4.311 4.318 4.323 24% 0.807 1.457 1.981 2.404 2.745 3.021 3.242 3.421 3.566 3.682 3.776 3.851 3.912 3.962 4.001 4.033 4.059 4.080 4.097 4.110 4.121 4.130 4.137 4.143 4.147 25% 0.800 1.440 1.952 2.362 2.689 2.951 3.161 3.329 3.463 3.571 3.656 3.725 3.780 3.824 3.859 3.887 3.910 3.928 3.942 3.954 3.963 3.971 3.976 3.981 3.985 Page 74 ... and b) above.” CMA Canada Page 2012 Sample Entrance Examination Calculator Policy and Supplement The following models of calculators are authorized for use on the Entrance Examination: Texas Instruments... 10Bii) EL-738C (EL-738) The supplement accompanying the Entrance Examination contains present value tables CMA Canada Page 2012 Sample Entrance Examination Corporate Finance QWC Ltd has cash.. .2012 Sample Entrance Examination TABLE OF CONTENTS Examination: Instructions Questions