Module 1: Economic Factors and Business Information

• Topic 01

  Analytical Methods and Economic Concepts

  147 questions
• Topic 02

  Financial Reporting

  139 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. What does the Revenue Recognition standard (ASC 606) say about when revenue should be recognised?

   • A
     Revenue is recognised only when the customer provides written acceptance of the goods or services
   • B
     Revenue is recognised when the invoice is sent, regardless of delivery status
   • C
     Revenue is recognised over the company's fiscal year on a straight-line basis
   • D
     Revenue is recognised when (or as) the company satisfies its performance obligation by transferring control of goods or services to the customer, in an amount that reflects the consideration expected in exchange
     Correct answer
   Explanation

   ASC 606 (Revenue from Contracts with Customers) establishes a five-step model: (1) identify the contract; (2) identify performance obligations; (3) determine transaction price; (4) allocate price to obligations; (5) recognise revenue as each obligation is satisfied. The core principle is recognising revenue when control of the good or service transfers to the customer — this may happen at a point in time (product delivery) or over time (service contracts). This replaced dozens of industry-specific standards.

2. A company purchases new equipment for $200,000. On which financial statement and in which section does this transaction appear?

   • A
     Income statement — Capital expenditures line item
   • B
     Cash flow statement — Investing activities (cash outflow)
     Correct answer
   • C
     Cash flow statement — Financing activities
   • D
     Balance sheet — Current assets
   Explanation

   Purchasing equipment is a capital expenditure (capex)—cash spent to acquire a long-term asset. It appears as a cash outflow in the Investing Activities section of the cash flow statement. On the balance sheet, the new equipment increases Property, Plant & Equipment (PP&E) under non-current assets. On the income statement, no immediate expense is recorded—instead, the cost is expensed over time through depreciation. This is the difference between a capital expenditure (capitalised on the balance sheet and depreciated over useful life) and an operating expense (immediately expensed on the income statement). This distinction is critical for analysts examining quality of earnings and free cash flow.

3. An analyst values a company's preferred stock as a perpetuity. The stock pays $6 annually and the required return is 7.5%. What is the intrinsic value of the stock, and how would the value change if the required return rose to 10%?

   • A
     The stock is worth $80 at 7.5%; if the required return rises to 10%, the value rises to $100
   • B
     The stock is worth $80 at 7.5%; if the required return rises to 10%, the value falls to $60
     Correct answer
   • C
     The stock is worth $75 at 7.5%; if the required return rises to 10%, the value falls to $55
   • D
     The stock is worth $60 at 7.5%; if the required return rises to 10%, the value falls to $40
   Explanation

   Perpetuity value = Payment / Required Return. At 7.5%: $6 / 0.075 = $80. At 10%: $6 / 0.10 = $60. This demonstrates the inverse relationship between required returns (discount rates) and present values: as required return increases, the value of any fixed-payment security falls. This is the same principle that causes bond prices to fall when interest rates rise. The fixed payment of $6 does not change; only the denominator (required return) changes, causing the price to move inversely.