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2013 CFA Level I FRA Quiz 1 Solution

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1. Information regarding off-balance sheet obligations will most likely be found in the:
A. Auditors report.
B. Management commentary.
C. Notes to the financial statements.
Answer: B
In the United States, the SEC requires listed companies to provide the Management Commentary,
also known as Managements Discussion and Analysis. Information regarding off-balance sheet
items is a component of the Management Commentary.
2. Which of the following opinions would an analyst like to see in a financial report?
A. Adverse Opinion.
B. Qualified Opinion.
C. Unqualified Opinion.
Answer: C
An unqualified opinion states that the financial statements give a true and fair view and is referred
to as the clean opinion. An adverse opinion is issued if the auditor believes that the financial
statements do not give a true picture of the company. A qualified opinion is given when there are
some exceptions to accounting standards.
3. An analyst has the following information for a company called MMS Ltd.
Gross Sales
$120,000
Net Sales
$101,500
Interest Expense
$15,000
Gross Assets
$600,000
Accumulated Depreciation
$250,000
Accounts Receivables
$64,000
Accounts Payable
$52,000
The allowance for bad debts is 5%.
Given the above data, what is the total amount for all contra asset accounts?
A. $ 271,100
B. $ 271,700
C. $ 286,700
Answer: B
Contra asset accounts are used to offset or deduct from another account in a balance sheet.
Examples of contra asset accounts are Allowance for bad debts, Accumulated Depreciation, and
Sales Returns and Allowances.
Therefore,
Allowance for bad debts = 5% of $ 64,000 = $3,200
Accumulated Depreciation = $ 250,000
Sales Returns and Allowances = $120,000 - $ 101,500 = $ 18,500
Total = $ 271, 700
4. David Clark, the accountant at Liberty Books Ltd, received 1,728 cash on July 1, 2012 for a
two-year subscription of the monthly newsletter. Which of the following statements is most
accurate?
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A. On July 1, 2012, the Subscription Earned account had a balance of 1,728 and the Cash
account had a balance of 1,728.
B. On March 1, 2013, the Subscription Earned account had a balance of 576 and the
Unbilled Subscription account had a balance of 1,152.
C. On March 1, 2013, the Subscription Earned account had a balance of 576 and the
Unearned Subscription account had a balance of 1,152.
Answer: C
Unearned or deferred revenue is when the company receives cash prior to earning the revenue while
unbilled revenue arises when a company earns revenue prior to receiving cash.
On July 1, 2012, David Clark would record 1,728 as an increase in Cash and an increase in
Unearned Subscription.
Eight months later, on March 1, 2013, the amount of Subscription Earned is:

Therefore, eight months later, subscription earned


The balances would thus be 576 in Subscription Earned account and 1,152 in Subscription
Unearned account.
5. Michael wishes to analyze the financial position of the company GHI Ltd. Which of the
following should Michael look into?
A. Assets
B. Expenses
C. Revenue
Answer: A
The financial statement components that are related to the financial position of the company include
Assets, Liabilities, and Equity. Expenses and Revenue are used to measure the performance of the
company.
6. Which of the following are two fundamental qualitative characteristics of Financial Reports?
A. Comparability and Timeliness
B. Comparability and Relevance
C. Faithful Representation and Relevance
Answer: C
Faithful Representation and Relevance are two fundamental qualitative characteristics of Financial
Reports. Comparability and Timeliness are enhancing qualitative characteristics.
7. On April 1, 2011, Rogers Construction Ltd entered into a contract of construction of four
schools. Linda, an analyst, managed to collect the following information regarding this contract
as at March 31, 2012.
Contract Completion Date: March 31, 2015
Total expected revenue: $240,000
Total expected cost: $180,000
Cost incurred during 2011: $120,000
How much revenue will be recorded if the company makes use of the
i. percentage completion method
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2013 CFA Level I FRA Quiz 1 Solution

ii. completed contract method


Percentage Completion
A.
$120,000
B.
$160,000
C.

$200,000

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Completed Contract
None
None
$160,000

Answer: B
Under the percentage completion method, the company estimates, in each accounting period, what
percentage of the contract is complete and reports that percentage of total revenue in the income
statement.
Therefore, percentage completed:
Revenue =
Under the completed contract method, no revenue would be reported until the contract is complete.
8. Samuel, an external auditor, came across an error made by the accountant, James, of the
company Anglo Ltd. For financial reporting purposes, James depreciated the Red Truck using a
straight line method and the following information:
Red Truck (Fixed Asset) Beginning Balance:
$72,000
Life of Asset:
8 years
Scrap Value:
$8,000
Assume that the asset was bought at the start of the current accounting period. Given that the
companys depreciation policy was to use the double declining method for vehicles, which of
the following statements is most accurate?
A. Due to the error made by James, the fixed assets were understated by $10,000.
B. Due to the error made by James, the fixed assets were overstated by $10,000.
C. Due to the error made by James, the fixed assets were overstated by $8,000.
Answer: B
Straight Line Depreciation
Depreciation Expense
Red Truck Year 1 Ending Balance =
Double Declining Method
Depreciation Expense
Red Truck Year 1 Ending Balance = $72,000
Therefore, due to the error made by James, the fixed assets were overstated by $10,000.
9. Mariah Care Products Ltd reported a net income of $1,400,000 for the year ended December 31,
2011. The company had outstanding common stock shares of 400,000 and 16,000 shares of
convertible preferred stock. Each preferred share paid a dividend of $10 per share and could be
converted to 4 shares. What was the companys diluted earnings per share?
A. $2.67
B. $3.01
C. $3.10
Answer: B
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Upon conversion, no dividends will be paid and the numerator will be the net income i.e. $
1,400,000.
Each preferred stock share can be converted into 4 shares of common stock. Therefore, additional
common stock shares = 16,000 x 4 = 64,000.
Total number of shares i.e. denominator = 64,000 + 400,000 = 464,000
Diluted EPS =
$3.01
10. An investor is concerned about the financial risk and financial leverage of a company. Which
ratios would the investor most likely study?
A. Acid Test Ratio
B. Debt-to-equity Ratio
C. Operating Profit Margin
Answer: B
Debt-to-Equity Ratio gives the debt per unit of equity and measures the financial leverage of the
company. The lower this ratio, the better it is for the company and the less the financial risk.
Acid Test Ratio is a measure of the liquidity of the company as it takes into account current assets
and current liabilities. The Operating Profit Margin is a measure of profitability of the company and
measures the companys performance.
11. During a lecture, Ted, a student, made the following statements.
Statement 1: Derivatives whether stand-alone or embedded in non-derivative instruments are
measured at Fair Value.
Statement 2: Unrealized gains from available-for-sale securities flow through net income
into retained earnings.
Which of the following is most accurate?
A. Statement 1 is correct, but Statement 2 is incorrect.
B. Statement 2 is correct, but Statement 1 is incorrect.
C. Both Statements are incorrect.
Answer: A
Derivatives are measured at Fair Value rather than at Historical Cost. On the other hand, unrealized
gains from available-for-sale securities are a component of accumulated other comprehensive
income. Therefore, Statement 1 is correct but Statement 2 is incorrect.
12. Following is an extract from the cash flow statement of a hypothetical company Guitars Ltd.
Sales proceeds from sale of minivan
$14,000
Cash paid for purchase of equipment
$25,000
Interest received
$2,850
Jonathan saw the above extract and stated, This extract shows cash flows from investing
activities and the company clearly follows the US GAAP classification of cash flows
Which of the following statements is most accurate?
A. Jonathan is correct about the cash flows from investing activities part but is not correct
about the US GAAP classification.
B. Jonathan is correct about the US GAAP classification part but is not correct about the
cash flows from investing activities.
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C. Jonathans statement is incorrect with respect to both cash flows from investing
activities and US GAAP classification parts.
Answer: A
Sales proceeds from sale of fixed assets and cash paid for purchase of fixed assets are considered
part of the Cash flows from Investing Activities in the Cash Flow Statement. Interest Received can
be recorded as part of Cash flows from Investing Activities under the classifications by IFRS.
Therefore, Jonathan is correct about cash flows from investing activities part but incorrect about
the US GAAP classification part. Under US GAAP, interest received is recorded as an Operating
Cash Flow.
13. For the year ended June 30, 2009, Advant Corporation reported sales revenue of PKR300, 000.
Given that accounts receivables decreased by PKR 20,000 and accounts payable increased by
PKR 8,000 during the year, what is the closest amount of cash collections for the year?
A. PKR 308,000
B. PKR 320,000
C. PKR 328,000
Answer: B
Cash collections = PKR 300,000 + PKR 20,000 = PKR 320,000
The change in accounts payable does not affect cash collections.
14. Norah, an analyst, wishes to calculate the payables payment period for a company. The revenue
of the company for the year ended equaled $250,000 and the gross profit margin was 25%.
Given an average accounts payable balance of $17,500, the payables payment period for the
company is closest to:
A. 27 days
B. 34 days
C. 42 days
Answer: B
Payables Payment Period
Cost of goods sold = 0.75 x 250,000 = 187,500
Payables Payment Period =
15. William, an investor, has the following information for a hypothetical company AFC Ltd.
Net Profit Margin = 10%
Asset Turnover = 45%
Financial Leverage = 1.6
Given that the company had revenue of $100,000 for the year ended, the equity of the company
is closest to:
A. $62,500
B. $125,000
C. $138,900
Answer: C
Return on Equity =
Return on Equity =
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Net Income =
Equity =
16. Primer Ltd started business in 2011 and uses the FIFO method to value its inventory. In May
2011, 67,500 units of inventory were purchased at $6 each and sold 60,000 units at $10 each. In
September 2011, it purchased another 40,000 units at $8 each and sold 25,000 units at $13 each.
What was the ending inventory balance in December 2011?
A. $135,000
B. $165,000
C. $180, 000
Answer: C
As the company uses the First in First Out method of inventory valuation, the first batch of 67,500
units shall first be used up and sold. The number of units sold from the second batch of inventory is
calculated as follows:
Batch 1
Units bought
67,500
Units sold
60,000
Units remaining
7,500
Batch 2
Units bought
40,000
Units sold
From batch 1
7,500
From batch 2
17,500
Units remaining
22,500
Ending Inventory = 22,500 x $8 = $180,000
17. In an inflationary environment, assuming stable inventory quantities, which of the following
most accurately describes the effect on Cost of Goods Sold of using FIFO as compared to
LIFO?
A. Lower
B. The Same
C. Higher
Answer: A
Compared to LIFO, Cost of Goods Sold calculated under FIFO would be lower because the ending
inventory would comprise of inventory at higher prices as the most recent units shall be assumed
unsold. As a result, the Cost of Goods Sold value would be lower.
18. Gray Inc. purchased tractors two years ago for $90,000. The tractors had a fair value of $78,000
at the end of last year. Market analysis revealed that the fair value this year is $94,000. What
amount, if any, will be recognized in the net income assuming that Gray Inc. uses the
revaluation model?
A. $ 0
B. $ 12,000
C. $ 16,000
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Answer: B
Using the revaluation model, the tractors are to be reported at fair value. At the end of last year, a
loss of $ 12,000 was recognized in the income statement. Any recovery that shall be reported in the
income statement in the following years shall only be to the extent of the loss. Therefore, at the end
of this year, $12,000 shall be recognized in the net income and $ 4,000 shall be recognized as a
revaluation surplus in shareholder equity.
19. Orange Ltd sold an intangible asset with acquisition cost of $13 million for $2.6 million. Given
that the accumulated amortization on the asset was $9.8 million, which of the following is most
likely the gain or loss reported on the sale of the asset?
A. $ 0.6 million loss
A. $ 0.6 million gain
B. $ 10.4 million loss
Answer: A
Gain or Loss on Sale = Sales proceeds Carrying value
Gain or Loss on Sale = 2.6 - (13 9.8) = - 0.6
Therefore, a loss of $0.6 million was incurred upon sale of asset.
20. Brians business does not do well in its first year of operation and reports a loss of $12,000.
Given the tax rate of 35%, which of the following shall be reported in the balance sheet?
A. Deferred Tax Asset $4,200
B. Deferred Tax Asset of $12,000
C. Deferred Tax Liability of $ 4,200
Answer: A
The tax loss carry-forward is shown on the balance sheet as deferred tax asset and is equal to the
loss incurred multiplied by the tax rate.
Therefore, deferred tax asset = 12,000 x 35% = $4200.
21. Which of the following is created when the income tax expense is higher than taxes payable?
A. Deferred Tax Asset
B. Deferred Tax Liability
C. Permanent Difference
Answer: B
A deferred tax liability is created when the income tax expense is higher than taxes payable. On the
other hand, a deferred tax asset is created when taxes payable are higher than the income tax
expense.
Permanent difference is a difference between taxable income and pretax income and does not create
deferred tax assets or deferred tax liabilities.
22. The following statements were made by three university students.
Scott: A bond is issued at a premium when the coupon rate of 10% is less than the market
prevailing rates of 12%.
Dave: Under the operating lease, being the lessee, I will be entitled to the legal ownership of the
asset.

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Mandy: The pension expense is the agreed upon amount contributed by the company under a
defined contribution plan.
How many statements are least accurate?
A. 1
B. 2
C. 3
Answer: B
A bond is issued at a discount when the coupon rate of 10% is less than the market prevailing rates
of 12%.
The financial lease allows for risks and rewards to be transferred and the lessee to be entitled to the
legal ownership of the asset, while the operating lease does not.
The pension expense is the agreed upon amount contributed by the company under a defined
contribution plan.
Therefore, both statements are inaccurate.
23. Given that a 5 year bond was issued at the beginning of June 2012 with a face value of $1
million and coupon rate of 12%. The market rates at the time of issue were 15%. The balance
sheet liability at the end of the first semiannual period is closest to:
A. $ 889,761
B. $ 904,317
C. $ 957,039
Answer: B
The liability at the start of the year is the Present Value
N=
10
I/Y =
15/2 = 7.5
FV =
$1,000,000
PMT =
$1,000,000 x (0.12/2)
Thus, PV = $897,039
The interest expense is the effective interest rate times the balance sheet liability:
(15/2) x 897,039 = $67, 278
As the bond was issued at a discount, the value of the liability will change over time and the
difference between the interest rate and actual cash payment will be added to the initial liability
amount.
The cash payment equals coupon rate x par value = (0.12/2) x 1,000,000 = $60,000
The difference is therefore $67,278 - $60,000 = $7,278
The liability at the end of the first semiannual period equals $897,039 + $7, 278 = $ 904,317
24. Revenues and expenses based on significant estimates that involve subjective judgments can
best be categorized as a part of which of the following fraud risk factors?
A. Attitudes and Rationalization
B. Incentives and Pressure
C. Opportunities
Answer: C
Revenues and expenses based on significant estimates that involve subjective judgments allow for
opportunities to conduct fraudulent activity. Thus its best categorized as Opportunities.
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25. Which of the following statements is most likely to cause earnings before interest and tax
(EBIT) to fall immediately?
A. Classifying a Financial Lease as an Operating Lease
B. Giving out cash dividends
C. Increasing the salvage value of depreciable assets
Answer: A
By classifying a Financial Lease as an Operating Lease, the rent expense increases and causes the
EBIT to fall.
Cash dividends are paid out from Net Income and therefore EBIT is not affected.
Increasing the salvage value reduces the depreciation expense and thus increases EBIT.
26. A company wishes to improve its Operating Cash flow. Which of the following actions is the
company most likely to take?
A. Decreasing the payables payment period.
B. Securitizing its receivables.
C. Selling off unused fixed assets.
Answer: B
When receivables are securitized, they are transferred to a special purpose entity and sold further
once a pool of receivables is created. This improves the operating cash flows because the
transaction is recorded as a sale.
Decreasing the payables payment period means that the vendors need to be paid off more quickly
than before and this decreases the operating cash flow rather than improving it.
Unused fixed assets may be sold or disposed off but this transaction impacts the Cash Flow from
Investing Activities.
27. Phil, an analyst, was studying two competitors of which Company A used the LIFO method of
inventory valuation and Company B used the FIFO method. In order to adjust inventory of
Company A, Phil made use of the following data.
January 1, 2012
December 31, 2012
Inventory
50,000
Increased by 25%
LIFO Reserve
6,000
Increased by 15%
Which of the following values for Ending Inventory in accordance to FIFO method did Phil
derive?
A. 62, 500
B. 63, 400
C. 69, 400
Answer: C
LIFO Ending Inventory can be adjusted to a FIFO basis by adding the LIFO reserve. Therefore,
Ending Inventory = 50,000 x 1.25 = 62,500
LIFO Reserve = 6,000 x 1.15 = 6,900
Ending Inventory FIFO = 62,500 + 6,900 = 69,400

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28. Little Lego had a current ratio of 1.25 and a quick ratio of 0.75. If it wishes to purchase new
inventory and finance it through bank overdraft, what would be the most likely impact on the
two aforementioned ratios?
A. None of the ratios will decrease.
B. Only one ratio would decrease.
C. Both ratios will decrease.
Answer: C
Assume that the current assets are 2.5 units, current liabilities are 2 units and inventory is 1 unit.
By purchasing inventory worth 1 more unit via short term debt, current assets are 3.5 units, current
liabilities are 3 units and inventory is 2 units.
The current ratio =
and quick ratio =
Thus both ratios will decrease.
29. Which of the following most accurately describes the
relationship in the DuPont
Equation?
A. Tax Burden
B. Interest Burden
C. EBIT Margin
Answer: A
Net Income/EBT is the Tax Burden and measures the effect of taxes on the ROE. It is reflective of
1-tax rate.
Interest Burden is EBT/EBIT whereas EBIT Margin is EBIT/Revenue.
30. Which of the following is least likely included in a common size balance sheet or common size
income statement?
A. Operating Profit Margin
B. Pre Tax Margin
C. Current Ratio
Answer: C
Operating Margin and Pre Tax Margins are percentages expressed as a percentage of Net Revenues.
On the other hand, Current Ratio =
and in common size balance sheet analysis,
Current Assets are presented as a percentage of Total Assets not that of Current Liabilities.
31. While studying the financial statements of Gram International Ltd, an analyst came across the
following information.
Net Income
$45 million
Depreciation
$16 million
Decrease in inventory
$2.4 million
Decrease in Rent Payable $1.8 million
Increase in Bonds Payable $15 million
Net Capital Expenditure
$10 million
Which of the following is the most accurate value of Free Cash Flow to the Firm (FCFF)?
A. $50.6 million
B. $51.6 million
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C. $66.6 million
Answer: B
Operating Cash Flow = Net Income Depreciation + Decrease in Inventory Decrease in Rent
Payable
Operating Cash Flow = 45 + 16 +2.4 1.8 = $61.6 million
Free Cash Flow to the Firm = Operating Cash Flow Net Capital Expenditure
Free Cash Flow to the Firm = 61.6 10 = $51.6 million.
32. Which of the following is least likely affected because of reporting a lease as an operating lease
rather than a financing lease by a lessee?
A. Debt-to-Equity Ratio
B. Operating Expenses
C. Total Cash Flow
Answer: C
Classifying the lease as financing or operating does not affect the Total Cash Flow. It only
determines the extent to which the lease payments are classified as Operating or Financing Cash
Flows.
An operating lease does not require recognition of a liability but a finance lease does, the debt-toequity ratio differs.
Under an operating lease, the lessee reports rent expense in the income statement and therefore
Operating Expenses differ for Operating and Financial Lease.
33. Cheesy Pizzas rented out a new place to open up another outlet. The rent paid at the end of the
year 2012 amounted to $2400 and was to cover the rent expense for five months up till May 31,
2013. The impact on the 2012 balance sheet can best be described as:
A. A decrease in Cash and an increase in rent expense.
B. A decrease in Cash and an increase in a prepaid liability account.
C. A decrease in Cash and an increase in a prepaid asset account.
Answer: C
When Cash is paid in advance for an expense not yet incurred, Cash decreases and a prepaid asset
account is created.
Rent expense will only increase in the Income Statement when incurred.
A prepaid liability account is only created if the expense is recorded before the cash payment has
been made.
34. Mini Tablets Ltds liabilities include a Treasury Bills that mature in 3 months, Commercial
Paper due in 270 days, vendors that have to be paid within 7 weeks, and notes payable due in 15
months. Which of these will be included in the Current Liabilities in Mini Tablet Ltds balance
sheet?
A. All but the Commercial Paper
B. All but the Notes Payable
C. All of the aforementioned liabilities
Answer: B

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Current Liabilities are due within one year which is the standard operating cycle for most of the
organizations. Therefore, all liabilities except Notes Payables should be classified as Current
Liabilities in Mini Tablet Ltds Balance Sheet.
35. Outstanding common stock shares for Little Woods Inc were 120,000 on January 1, 2011. The
company repurchased 20,000 shares on June 1 followed by a stock split of 2 on July 1. Which of
the following is the most accurate value for weighted average shares outstanding for the year?
A. 173,333
B. 200,000
C. 216,667
Answer: C
The number of shares outstanding for the first 5 months is 120,000 and for the remaining 7 months
are 100,000. These should be multiplied by 2 to take into account the effect of a stock split.
= 216, 667
36. An analyst makes the following statements regarding Financial Statements.
Statement I: The periodic as well as annual financial statements should be audited before they
are presented to investors.
Statement II: The footnotes to financial statements include legal proceedings as well as
commitments and contingencies.
Are the analysts statements accurate?
A. Both of these statements is accurate
B. Neither of these statements is accurate
C. Only one of these statements is accurate
Answer: C
The annual financial statements are audited, while the periodic statements are not audited. Thus
Statement I is inaccurate.
Statement II is accurate.
37. Given below is selected data from Panama Ltds financial statements for the year 2010 and
2011.
2011
2010
10%, $100 par, Preferred Stock
$20 million
$20 million
$10 par, Common Stock
$8 million
$7 million
Additional paid-in capital, Common Stock
$30 million
$25 million
Retained Earnings
$40 million
$36 million
Treasury Stock
$3 million
$1 million
Net Income
$15 million
$12 million
To calculate Return on Equity, which of the following most accurately gives the value of
average common equity?
A. $35 million
B. $71 million
C. $73 million
Answer: B
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Common Equity = Common Stock + Additional Paid-in Capital + Retained Earnings Treasury
Stock
Common Equity, 2010 = 7 + 25 + 36 1 = 67
Common Equity, 2011 = 8 + 30 + 40 3 = 75
Average Common Equity =
38. Which of the following is the most likely impact of using FIFO rather than LIFO in an economy
experiencing inflation?
A. Lower Ending Inventory
B. Higher Inventory Turnover
C. Higher Income Taxes
Answer: C
During inflation, using FIFO as a method of inventory valuation results in ending inventory
comprising of higher priced goods and therefore a higher value of Ending Inventory. As the Ending
Inventory is greater, Cost of Goods Sold is lower and therefore the Inventory Turnover is lower. A
lower Cost of Goods Sold value causes Gross Profit and therefore Net Profit to be higher and thus
income taxes are higher.
39. Which of the following industries is most likely to have low accounts receivables?
A. Telecommunications
B. Machinery and other industrials
C. Consumer Discretionary
Answer: A
Telecommunications has the lowest accounts receivables as it has negligible credit sales compared
to Industrials and Consumer Discretionary.
40. Which of the following documents sorts out business transactions by account?
A. General Journal
B. General Ledger
C. Adjusted Trial Balance
Answer: B
A general journal sorts out business transactions by date whereas a general ledger sorts out business
transactions by account in the form of T-Accounts.
An adjusted trial balance lists account balances once adjusting entries have been made.

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