areaIII A. Accounting changes and error corrections Flashcards
Accounting Changes
There are two types of accounting changes:
● Change in Accounting Principle: This involves a change from one generally accepted accounting principle (GAAP) to
another. For example, switching from FIFO (First-In, First-Out) to LIFO (Last-In, First-Out) inventory accounting. change in accounting principle requires retrospective change by restating prior financial statements.
● Change in Accounting Estimate: This happens when an estimate is revised due to new information or new experience. For instance, changing the useful life of a fixed
asset. This requires prospective change by reflecting the change on now and future financial statements.
Error Corrections refer to
the adjustments made to correct errors resulting from mathematical mistakes, mistakes in applying accounting
principles, or oversight or misuse of facts that existed at the time the financial statements were prepared. understatement of inventory requires retrospective change to financial statements.
FAR1A001n
Which organization creates GAAP or the Generally Accepted Accounting Principles?
A. The Financial Accounting Standards Board
B. The Financial Accounting Standards Body
C. The Securities and Exchange Commission
D. The American Institute of Certified Public Accountants
A. The Financial Accounting Standards Board
FASB, the Financial Accounting Standards Board, is the organization that creates and updates the accounting standards that make up GAAP. FASB doesn’t have legal authority to enforce GAAP, since it is a private organization appointed by the government.
Polk Co. acquires a forklift from Quest Co. for $30,000.
The terms require Polk to pay $3,000 down and finance the remaining $27,000.
On March 1, year 1, Polk pays the $3,000 down and accepted delivery of the forklift. Polk signed a note that requires Polk to pay principal payments of $1,000 per month for 27 months beginning July 1, year 1.
What amount should Polk report as an investing activity in the statement of cash flows for the year ended December 31, year 1?
A. $3,000
B. $9,000
C. $12,000
D. $30,000
A. $3,000
Only the $3,000 down payment would be an investing activity. The payments would be classified as a financing activity.
FAR3B10010
Which of the following best describes the ‘principle of prudence’ in relation to contingencies?
A. Recognizing all possible losses but no gains until they are realized.
B. Avoiding any recognition of contingencies to prevent speculation.
C. Recognizing gains as soon as they are probable.
D. Disclosure of contingencies in the management discussion and analysis section.
A. Recognizing all possible losses but no gains until they are realized.
The principle of prudence involves recognizing all potential losses when they are possible, and gains only when realized.
FAR1E10012
A business receives $24,000 for services to be delivered evenly over the next 12 months. What is the correct entry after one month on an accrual basis?
A) Debit Unearned Revenue $2,000, Credit Revenue $2,000
B) Debit Cash $24,000, Credit Revenue $24,000
C) Debit Unearned Revenue $24,000, Credit Revenue $24,000
D) Debit Cash $2,000, Credit Revenue $2,000
A) Debit Unearned Revenue $2,000, Credit Revenue $2,000
On an accrual basis, revenue is recognized when earned. After one month, $2,000 of service (1/12 of $24,000) has been delivered. This entry reduces the liability (unearned revenue) and recognizes the earned revenue.
A company recently moved to a new building. The old building is being actively marketed for sale, and the company expects to complete the sale in four months. Each of the following statements is correct regarding the old building, except:
A. It will be reclassified as an asset held for sale.
B. It will be classified as a current asset.
C. It will no longer be depreciated.
D. It will be valued at historical cost.
D. It will be valued at historical cost.
Once an asset is being held for sale, it is no longer PPE and isn’t depreciated, nor will it be valued at historical cost – it will be held at net realizable value until it is sold. The other responses are true.
FAR3C10028
Which of the following best describes funds received by a not-for-profit entity for a specified beneficiary where the entity has no variance power?
A. A contribution to the entity
B. An agency transaction
C. An unrestricted donation
D. A conditional promise to give
B. An agency transaction
Funds received by a not-for-profit entity for a specified beneficiary, where the entity has no variance power, are treated as an agency transaction, not as a contribution to the entity.
FAR2D10039
Which statement is true regarding the costs to sell an asset held for sale?
A. They are capitalized and added to the asset’s carrying amount
B. They are expensed as incurred
C. They are ignored in measuring the asset’s fair value less costs to sell
D. They are amortized over the expected period until the sale
B. They are expensed as incurred
Costs to sell are expensed as incurred and are not capitalized or added to the asset’s carrying amount.
If a company uses the aging method for its allowance for doubtful accounts, how would this impact its rollforward analysis of trade receivables?
A) It increases the trade receivables balance
B) It decreases the trade receivables balance
C) It is included as a separate line item in the rollforward
D) It has no direct impact on the trade receivables rollforward
D) It has no direct impact on the trade receivables rollforward
The aging method affects the allowance for doubtful accounts and the net realizable value of receivables but does not directly change the gross trade receivables balance in a rollforward analysis.
FAR3G10004
Which of the following situations would typically require an adjustment to the financial statements as a subsequent event?
A) A major customer declaring bankruptcy after the balance sheet date.
B) A significant decline in market value of investments after the balance sheet date.
C) The discovery of an error in the financial statements after they have been issued.
D) The sale of a major division of the company after the balance sheet date.
A) A major customer declaring bankruptcy after the balance sheet date.
If a major customer declares bankruptcy after the balance sheet date and this bankruptcy reflects the customer’s financial condition as of the balance sheet date, it is considered a Type I subsequent event. Such events provide additional evidence about conditions that existed at the balance sheet date and typically require an adjustment to the financial statements.
FAR2D10042
In subsequent periods, how should an impairment loss recognized on an asset held for sale be reversed if the fair value less costs to sell increases?
A. The impairment loss can be reversed up to the newly estimated fair value less costs to sell
B. The impairment loss cannot be reversed
C. The impairment loss is reversed fully regardless of the new fair value
D. Only half of the impairment loss can be reversed
B. The impairment loss cannot be reversed
For assets classified as held for sale, once an impairment loss is recognized, it cannot be reversed in subsequent periods even if the fair value less costs to sell increases.
FAR3F10001
How should a lessee account for a residual value guarantee in a leasing arrangement?
A. Recognize as a liability at the inception of the lease.
B. Expense it evenly over the lease term.
C. Recognize as an asset at the inception of the lease.
D. Include in the measurement of lease liabilities and right-of-use assets.
D. Include in the measurement of lease liabilities and right-of-use assets.
The appropriate treatment for a residual value guarantee by the lessee is to include it in the measurement of lease liabilities and right-of-use assets. This is because the guarantee is a part of the future lease payments, impacting the total lease obligation and the corresponding asset recognized.
FAR1A40010
In the context of a statement of changes in equity, what does ‘other comprehensive income’ include?
A) Regular business expenses.
B) Profits from day-to-day operations.
C) Gains and losses not recognized in the profit or loss.
D) Dividends paid to shareholders.
C) Gains and losses not recognized in the profit or loss.
Other comprehensive income includes items of income and expense that are not recognized in the profit or loss as required or permitted by other IFRSs.
This does not include regular business expenses (Option A) or profits from day-to-day operations (Option B), which are part of the income statement. It also does not include dividends paid to shareholders (Option D), as these are distributions of profit, not components of comprehensive income.
FAR2G10030
What happens to the ARO liability and ARC when the associated asset is sold before the retirement obligation is settled?
A) The ARO liability and ARC are transferred to the new owner.
B) The ARO liability is settled, and ARC is removed from the balance sheet.
C) The ARO liability and ARC are derecognized, and a gain or loss is recognized.
D) The ARO liability is maintained, and ARC continues to be depreciated.
C) The ARO liability and ARC are derecognized, and a gain or loss is recognized.
Upon the sale of the asset, both the ARO liability and the ARC are derecognized, and any resulting gain or loss is recognized in the income statement.
FAR2H004n
Drake Inc. recorded in its books a loan obtained on January 1, year 2. The loan is a 8%, $1,000,000 loan with interest due annually on December 31. Drake did not record or pay the required year 2 interest payment until January 1, year 3.
Calculate the interest expense Drake should record on December 31, year 2.
A. $80,000
B. $0
C. $1,080,000
D. $40,000
A. $80,000
Interest amount calculation: $1,000,000 x 8% = $80,000
Provision for liability entry to be recorded in the books on December 31, year 2:
Debit: Interest expense $80,000
Credit: Accrued interest payable $80,000
FAR2D10018
A piece of equipment with a cost of $100,000, accumulated depreciation of $40,000, and a remaining loan balance of $30,000 is sold for $70,000. What is the gain or loss on the sale?
A. Gain of $10,000
B. Loss of $10,000
C. Gain of $30,000
D. No gain or loss
A. Gain of $10,000
The book value is the cost ($100,000) minus accumulated depreciation ($40,000), equaling $60,000. The sale price is $70,000. Thus, the gain is $70,000 – $60,000 = $10,000. The loan balance does not affect the calculation.
Hudson Corp. operates several factories that manufacture medical equipment. The factories have a historical cost of $200 million. Near the end of the company’s fiscal year, a change in business climate related to a competitor’s innovative products indicated to Hudson’s management that the $170 million carrying amount of the assets of one of Hudson’s factories may not be recoverable. Management identified cash flows from this factory and estimated that the undiscounted future cash flows over the remaining useful life of the factory would be $150 million. The fair value of the factory’s assets is reliably estimated to be $135 million. The change in business climate requires investigation of possible impairment. Which of the following amounts is the impairment loss?
A. $15 million
B. $20 million
C. $35 million
D. $65 million
C. $35 million
To test for an impairment loss, there are two steps:
Is the carrying value greater than the undiscounted cash flows? In this case yes, so step two is:
Subtract fair value from carrying value: $170 million – $135 million = $35 million impairment
FAR1B30008
How does the statement of cash flows complement the balance sheet in a not-for-profit entity?
A. By providing a detailed analysis of the entity’s market value.
B. By showing changes in the entity’s equity structure.
C. By explaining the changes in cash balances reported on the balance sheet.
D. By revealing the entity’s creditworthiness to lenders.
C. By explaining the changes in cash balances reported on the balance sheet.
The statement of cash flows complements the balance sheet by detailing the reasons behind changes in cash balances over the period, linking the opening and closing balances of cash on the balance sheet.
FAR1A20025
If a company failed to record the write-down of inventory, the necessary adjustment in the income statement would be to:
A) Increase the cost of goods sold.
B) Decrease the cost of goods sold.
C) Increase operating income.
D) No adjustment needed as inventory write-downs affect only the balance sheet.
A) Increase the cost of goods sold.
A write-down of inventory should be reflected as an increased cost of goods sold, affecting net income.
B) is incorrect as it decreases cost of goods sold, which is contrary to the needed adjustment. C) is incorrect as the write-down decreases, not increases, operating income. D) is incorrect because inventory write-downs affect both the balance sheet and the income statement.
White Inc owes a bank $500,000 and one year of accrued interest at 10%. White is having financial difficulties and the bank agrees to restructure the loan to be $200,000 due in 10 years at the same 10% interest. What gain would White recognize on this debt restructuring?
A. There is no gain
B. $150,000
C. $240,000
D. $300,000
B. $150,000
The gain in this type of question compares the original loan amount to the total cash flows of the new deal.
The original loan is $500,000 + $50,000 of accrued interest = $550,000.
The cash flows from the new agreement total: $20,000 per year interest for 10 years = $200,000 + the new $200,000 principal amount = $400,000.
So overall White was relieved of $150,000 (550,000 – 400,000), so the gain is $150,000.
FAR2G10017
A company announces a voluntary redundancy program and estimates that 30% of eligible employees will accept. How should this be accounted for?
A) As a liability for the estimated 30% acceptance rate.
B) No liability is recognized until actual acceptances are received.
C) Recognized as a liability for all eligible employees.
D) Expensed in the income statement as a contingent liability.
A) As a liability for the estimated 30% acceptance rate.
A liability should be recognized based on a reasonable estimate of the number of employees expected to accept the offer.
FAR3E10026
What is the primary difference between Level 2 and Level 3 inputs in the fair value hierarchy?
A. Level 2 inputs are observable, while Level 3 inputs are not.
B. Level 2 inputs are for liabilities only, while Level 3 inputs are for assets only.
C. Level 2 inputs use historical cost, while Level 3 inputs use replacement cost.
D. Level 2 inputs are based on market participant assumptions, while Level 3 inputs are not.
A. Level 2 inputs are observable, while Level 3 inputs are not.
The primary distinction between Level 2 and Level 3 inputs is observability. Level 2 inputs are observable in the market, albeit not as directly as Level 1 inputs. Level 3 inputs are not observable and require significant estimation and judgment.
FAR3C10001
Which of the following is the first step in the five-step revenue recognition model?
A. Determine the transaction price
B. Identify the contract with a customer
C. Recognize revenue when or as performance obligations are satisfied
D. Allocate the transaction price to the performance obligations in the contract
B. Identify the contract with a customer
The first step in the five-step revenue recognition model is to identify the contract with a customer. This step is crucial as it establishes the formal agreement between the parties that creates enforceable rights and obligations.
A is incorrect because determining the transaction price is the third step. C is incorrect as recognizing revenue is the fifth and final step. D is incorrect because allocating the transaction price is the fourth step.
