CFA Level II Financial Statement Analysis Practice Questions
Question 1
A manufacturer's actuary raises the assumed discount rate on its defined benefit plan by 100 basis points, with all other assumptions unchanged. An analyst reviewing the next annual report should expect which effect?
- A. A lower projected benefit obligation and lower service cost
- B. A lower projected benefit obligation but higher service cost
- C. A higher projected benefit obligation and higher service cost
- D. A higher projected benefit obligation but lower service cost
Show answer and explanation
Correct answer: A. A lower projected benefit obligation and lower service cost
A higher discount rate reduces the present value of future benefits, lowering both the PBO and current service cost, which is based on the present value of benefits earned in the year. Interest components may move differently, but the obligation and service cost fall.
- A. Correct: discounting at a higher rate lowers the present value of both the obligation and benefits earned.
- B. Service cost is also a present value and falls with the higher rate.
- C. Present values move opposite to the discount rate, so the PBO cannot rise.
- D. The PBO does not rise with a higher discount rate; the direction is reversed.
Question 2
A US GAAP sponsor reports pension cost of USD 100 million, made up of service cost 70, interest cost 90, expected return on plan assets (80) and amortization of actuarial losses 20. The actual return on plan assets was USD 110 million. An analyst wants a pension cost that reflects economic reality by removing amortization and substituting the actual return. What adjusted pension cost results?
- A. USD 70 million
- B. USD 50 million
- C. USD 80 million
- D. USD 100 million
Show answer and explanation
Correct answer: B. USD 50 million
Adjusted cost = service cost + interest cost - actual return = 70 + 90 - 110 = 50. Amortization of prior actuarial losses is a smoothing item and is removed, and the actual return replaces the expected return of 80.
- A. Swaps in the actual return but leaves the 20 amortization in the cost.
- B. Correct: 70 + 90 - 110 = 50.
- C. Removes the amortization but keeps the expected return of 80 instead of the actual return.
- D. Is the reported figure; no analyst adjustment was made.
Question 3
Teal Inc. reported net income of USD 2,000,000 and had 1,000,000 weighted average shares outstanding. It has 100,000 employee options exercisable at USD 20 each, and the average market price for the year was USD 25. Using the treasury stock method, what is diluted EPS?
- A. USD 2.00
- B. USD 1.82
- C. USD 1.96
- D. USD 2.04
Show answer and explanation
Correct answer: C. USD 1.96
Assumed proceeds of 100,000 x 20 = 2,000,000 repurchase 80,000 shares at 25, so incremental shares = 100,000 - 80,000 = 20,000. Diluted EPS = 2,000,000 / 1,020,000 = 1.96.
- A. Is basic EPS; the in-the-money options were ignored.
- B. Adds all 100,000 options without assuming buyback of shares with the proceeds.
- C. Correct: 2,000,000 / 1,020,000 = 1.96.
- D. Subtracts the incremental shares instead of adding them (2,000,000 / 980,000).
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At the start of the year a pension plan has a defined benefit obligation of USD 1,000 million and plan assets of USD 900 million. The discount rate is 5%, the expected long-term return on assets is 7%, and current service cost is USD 60 million. There are no past service costs or settlements. The sponsor reports under IFRS. What pension expense is recognized in profit or loss for the year?
- A. USD 47 million
- B. USD 65 million
- C. USD 110 million
- D. USD 60 million
Show answer and explanation
Correct answer: B. USD 65 million
Under IFRS, profit or loss includes current service cost plus net interest on the net defined benefit liability at the discount rate: 60 + 5% x (1,000 - 900) = 65. The expected return assumption is not used, and remeasurements go to OCI.
- A. Uses the 7% expected return on assets (60 + 50 - 63), a US GAAP-style calculation not used under IFRS.
- B. Correct: 60 service cost + 5 net interest = 65.
- C. Adds interest on the full obligation but never offsets it with any return on assets.
- D. Counts service cost only and omits the net interest component.