Basic Concepts Flashcards Preview

CPA - FAR > Basic Concepts > Flashcards

Flashcards in Basic Concepts Deck (157):
1

After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. Which of the following statements about subsequent reversal of a previously recognized impairment loss is correct?

  1. It is prohibited.
  2. It is required when the reversal is considered permanent.
  3. It must be disclosed in the notes to the financial statements.
  4. It is encouraged, but not required.

It is prohibited for GAAP. (IFRS allows this under certain conditions)

All intangibles are subject to impairment, but the resulting impairment losses cannot be reversed. Although impairment losses on plant assets held for disposal can be reversed to the extent of previous losses, this is not the case for intangibles.

2

Magazine subscriptions collected in advance are reported as

  1. A contra account to magazine subscriptions receivable in the asset section of the balance sheet.
  2. Deferred revenue in the liability section of the balance sheet.
  3. Deferred revenue in the stockholders’ equity section of the balance sheet.
  4. Magazine subscription revenue in the income statement in the period collected. Answer Explanations

Deferred revenue in the liability section of the balance sheet.

Deposits and prepayments received for goods or services to be provided in the future are deferred revenues. These would be reported as liabilities because an enterprise has an obligation to provide goods or services to those who have paid in advance.

3

On December 31, 2003, Moon, Inc. authorized Luna Co. to operate as a franchisee for an initial franchise fee of $100,000. Luna paid $40,000 on signing the agreement and signed an interest-free note to pay the balance in three annual installments of $20,000, beginning December 31, 2004. On December 31, 2003, the present value of the note, appropriately discounted, is $48,000. Services for the initial fee will be performed in 2004. In its December 31, 2003, balance sheet, what amount should Moon report as unearned franchise fees?

  1. $0
  2. $48,000
  3. $88,000
  4. $100,000

$88,000

The unearned fees (current liability) balance is the sum of $40,000 cash received, plus the $48,000 present value of the note, for a total of $88,000. The remaining $12,000 (3 x $20,000 less the $48,000 present value) is interest to be recognized over the note term. No revenue is recognized until the service is performed.

4

edwood Co.'s financial statements had the following information at year end:

  • Cash $60,000
  • Accounts receivable $180,000
  • Allowance for uncollectible accounts $8,000
  • Inventory $240,000
  • Short-term marketable securities $90,000
  • Prepaid rent $18,000
  • Current liabilities $400,000
  • Long-term debt $220,000

What was Redwood's quick ratio?

0.81 to 1

The quick ratio is the quotient of very liquid current assets to total current liabilities. Inventories and prepaids are not included in the numerator because they are not considered sufficiently liquid. As such, it is a more stringent test of liquidity than the current ratio. In this case, the quick ratio consists of: cash + net AR + marketable securities divided by current liabilities: ($60,000 + $180,000 - $8,000 + $90,000)/$400,000) = .805. The closest answer is 0.81 to 1.

5

In determining the fair value of an asset or liability, would the fair value of the asset or the fair value of the liability be determined using an entry price or an exit price?

  1. Asset Fair Value   
  2. Liability Fair Value

  1. Asset Fair Value - EXIT PRICE   
  2. Liability Fair Value - EXIT PRICE

The appropriate basis for determining the fair value of an asset or a liability is an exit price.

6

In November and December Year 1, Dorr Co., a newly organized magazine publisher, received $72,000 for 1,000 3-­year subscriptions at $24 per year, starting with the January Year 2 issue. Dorr elected to include the entire $72,000 in its Year 1 income tax return. What amount should Dorr report in its Year 1 income statement for subscriptions revenue?

  1. $0
  2. $4,000
  3. $24,000
  4. $72,000

$0

SFAC 5 states that revenues are to be recognized when realized or realizable, and earned. At 12/31/Y1, none of the subscription revenue has been earned, since magazine delivery will not begin until Year 2. Therefore, unearned subscriptions revenue in the 12/31/Y1 balance sheet is $72,000 and subscriptions revenue in the Year 1 income statement is $0. Note that the treatment of the $72,000 collection for tax purposes does not determine its treatment for financial accounting purposes.

7

The FASB is a(n):

  1. Private sector body.
  2. Governmental unit.
  3. International organization.
  4. Group of accounting firms.

Private sector body.

The FASB has no official connection with the U.S. Government although the SEC, an agency of the federal government, can modify or rescind an accounting standard adopted by the FASB.

Remember the SEC has authority to establish GAAP but delegated that distinction to the FASB.

8

When the fair value of an asset is determined as the amount that currently would be required to replace the service capacity of the asset, which one of the following valuation techniques has been used?

  1. Income approach.
  2. Cost approach.
  3. Expense approach.
  4. Market approach.

Cost approach.

When fair value is determined as the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), the cost approach has been used.

9

For a firm that elects to use fair value to measure eligible financial assets and financial liabilities, specific disclosures are required for which of the following financial statements?

  1. Quarterly Financial Statements   
  2. Annual Financial Statements

  1. Quarterly Financial Statements - YES
  2. Annual Financial Statements - YES

Firms which elect to measure financial assets and financial liabilities at fair value are required to make significant additional disclosures in both interim (quarterly, etc.) and annual financial statements.

10

Entor Co. sold equipment to Pane Co. for $50,000.  The equipment had a net book amount of $30,000. The collections were $20,000 in the first year, $15,000 in the next year, and $15,000 in the last year.  What is the amount of gross profit for the third year if Entor used the installment-sales accounting method for the transaction?

  1. $0
  2. $5,000
  3. $6,000
  4. $15,000

$6,000

The total gross profit on the equipment is $50,000 – $30,000 = $20,000.  Under the installment-sales method, gross profit is recognized proportionally with the amount of the installment payment each year.  The gross profit that should be recognized in year 3 is $15,000/($20,000 + $15,000 + $15,000) = 30% of the total revenue.  Therefore, this answer is correct because $6,000 (30% × $20,000 total gross profit) of gross profit should be recognized in year 3.

11

According to the FASB conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?

  1. Replacement cost.
  2. Current market value.
  3. Historical cost.
  4. Net realizable value.

Replacement cost.

Current market value is a SELLING PRICE. Accounting standards define current replacement cost, as the amount of cash, or its equivalent, that would have to be paid if the same or an equivalent asset were acquired currently.

12

Recognizing depletion expense is an example of the accounting process of

  • Allocation
  • Amortization

  • Allocation - YES
  • Amortization - YES

SFAC 6 defines allocation as the process of assigning or distributing an amount according to a plan or formula and amortization as an allocation process for accounting for prepayments and deferrals. Allocation is broader in scope and thus includes amortization. Specific examples of amortization include recognizing expenses for depletion, depreciation, and insurance, and recognizing earned subscription revenues.

Under accrual accounting, expenses are recognized as related revenues are recognized, that is, (product) expenses are matched with revenues.  Some (period) expenses, however, cannot be associated with particular revenues. These expenses are recognized as incurred.

  1. Product costs are those which can be associated with particular sales (e.g., cost of sales). Product costs attach to a unit of product and become an expense only when the unit to which they attach is sold.  This is known as associating “cause and effect.”
  2. Period costs are not particularly or conveniently assignable to a product.  They become expenses due to the passage of time by
  • Immediate recognition if the future benefit cannot be measured (e.g., advertising)
  • Systematic and rational allocation if benefits are produced in certain future periods (e.g., asset depreciation)

13

On January 2, year 1, Smith purchased the net assets of Jones’ Cleaning, a sole proprietorship, for $350,000, and commenced operations of Spiffy Cleaning, a sole proprietorship.  The assets had a carrying amount of $375,000 and a market value of $360,000. In Spiffy’s cash-basis financial statements for the year ended December 31, year 1, Spiffy reported revenues in excess of expenses of $60,000.  Smith’s drawings during year 1 were $20,000.  In Spiffy’s financial statements, what amount should be reported as Capital-Smith?

  1. $390,000
  2. $400,000
  3. $410,000
  4. $415,000

$390,000

The ending balance in Smith’s capital account on either the accrual or cash basis is computed as follows:

  • Beginning capital + Investments + Income – Drawings = Ending capital

Smith’s beginning capital balance is measured as the cost of the assets purchased to establish the business ($350,000).  The previously recorded value ($375,000) and estimated market value ($360,000) are irrelevant and do not affect beginning capital. No additional investments were made; cash basis income was $60,000 and drawings were $20,000. Therefore, the ending capital balance is $390,000 ($350,000 + $60,000 − $20,000).

14

A private entity is defined as:

  1. An entity required to file with the SEC or a business entity that is required to prepare and make publicly available U.S. GAAP financial statements.
  2. The same as a public entity.
  3. An entity other than a public business entity, a not-for-profit entity, or Topic 960–965 employee benefit plan.
  4. An entity other than a public business entity or not-for-profit entity.

An entity other than a public business entity, a not-for-profit entity, or Topic 960–965 employee benefit plan.

A private entity is defined a private entity is defined as, "an entity other than a public business entity, a not-for-profit entity, or an employee benefit plan within the scope of Topics 960 through 965 on plan accounting."

15

Rent revenue collected 1 month in advance should be accounted for as

  1. Revenue in the month collected.
  2. A current liability.
  3. A separate item in stockholders’ equity.
  4. An accrued liability.

A current liability.

Revenue collected 1 month in advance is unearned and, therefore, should be accounted for as a current liability. Current liabilities are obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets or the creation of other current liabilities. This includes collections received in advance of delivery of goods or services.

Accrual —accrual-basis recognition precedes (leads to) cash receipt/expenditure

  • Revenue—recognition of revenue earned, but not received
  • Expense—recognition of expense incurred, but not paid  

Deferral —cash receipt/expenditure precedes (leads to) accrual-basis recognition

  • Revenue—postponement of recognition of revenue; cash is received, but revenue is not earned
  • Expense—postponement of recognition of expense; cash is paid, but expense is not incurred

 

 

16

Alta Co. spent $400,000 during the current year developing a new idea for a product that was patented during the year. The legal cost of applying for a patent license was $40,000. Also, $50,000 was spent to successfully defend the rights of the patent against a competitor. The patent has a life of 20 years. Under U.S. GAAP, what amount should Alta capitalize related to the patent?

  1. $40,000
  2. $50,000
  3. $90,000
  4. $490,000

$90,000

The legal cost for applying for a patent can be capitalized. Alta can also capitalize the costs associated with the legal defense of the patent. This response correctly includes the legal costs associated with applying for and defending the patent.

17

In accordance with ASC Topic 255, the Consumer Price Index for All Urban Consumers is used to compute information on a

  1. Historical cost basis.
  2. Current cost basis.
  3. Constant dollar basis.
  4. Nominal dollar basis.

Constant dollar basis.

The Consumer Price Index is used to compute information on a "constant dollar" basis. The index is used to restate financial statement elements to dollars which have the same purchasing power.

18

Which of the following should be expensed as incurred by a franchise with an estimated useful life of 10 years?

  1. Amount paid to the franchisor for the franchise.
  2. Periodic payments to a company, other than the franchisor, for that company’s franchise.
  3. Legal fees paid to the franchisee’s lawyers to obtain the franchise.
  4. Periodic payments to the franchisor based on the franchisee’s revenues.

Periodic payments to the franchisor based on the franchisee’s revenues.

Continuing franchise fees, based on revenues, should be reported as expenses when incurred. 

ASC Topic 952 provides that the initial franchise fee be recognized as revenue by the franchiser only upon substantial performance of their initial service obligation.  The amount and timing of revenue recognized depends upon whether the contract contains bargain purchase agreements, tangible property, and whether the continuing franchise fees are reasonable in relation to future service obligations.  Direct franchise costs are deferred until the related revenue is recognized.

19

Which of the following is a fundamental (primary) qualitative characteristic of useful financial information included in IASB's Framework?

  1. Comparability.
  2. Timeliness.
  3. Relevance.
  4. Understandability.

Relevance.

Relevance and faithful representation are the two fundamental qualitative characteristics of financial information (IASB Framework 5-18).

Same as GAAP!

20

According to the FASB Conceptual Framework, which of the following relates to both relevance and faithful representation?

  • Consistency
  • Verifiability

  • Consistency - YES
  • Verifiability - YES

Verifiability and consistency (a component of comparability) are both enhancing qualitative characteristics relating to both relevance and faithful representation.

21

According to the IASB Framework, the financial statement element that is defined as increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants, is

  1. Revenue.
  2. Income.
  3. Profits.
  4. Gains.

Income.

The IASB Framework has five elements:

  1. asset,
  2. liability,
  3. equity,
  4. income, and
  5. expense.

The definition given is that of income. Note that income includes both revenues and gains.

22

A company is an accelerated filer that is required to file Form 10-K with the United States Securities and Exchange Commission (SEC). What is the maximum number of days after the company's fiscal year end that the company has to file Form 10-K with the SEC?

  1. 60 days.
  2. 75 days
  3. 90 days
  4. 120 days

75 days. (Large Accelerated is 60 Days)

An accelerated filer has an aggregate worldwide market value of the voting and nonvoting common stock held by nonaffiliates of $75 million or more, but less than $700 million on the last business day of the issuer's most recently completed second fiscal quarter. A large accelerated filer has market capitalization (as described) of $700 million or more. Beginning in 2006 the SEC changed the 10-K filing deadline for large accelerated filers to be 60 days from the fiscal year end. Accelerated filers still have 75 days to file their 10-K.

23

Under what condition is it proper to recognize revenues prior to the sale of the merchandise?

  1. When the ultimate sale of the goods is at an assured sales price.
  2. When the revenue is to be reported as an installment sale.
  3. When the concept of internal consistency (of amounts of revenue) must be complied with.
  4. When management has a long-established policy to do so.

When the ultimate sale of the goods is at an assured sales price.

Profit is to be considered realized when a sale in the ordinary course of business is effected. Inventory valuation above cost can only be justified by the following: an inability to determine approximate costs, immediate marketability at a quoted price, and the characteristic of unit interchangeability. Thus, a condition permitting recognition of revenue prior to sale would be an assured sales price.

24

On January 2, 2005, Ames Corp. signed an eight-year lease for office space. Ames has the option to renew the lease for an additional four-year period on or before January 2, 2012. During January 2005, Ames incurred the following costs:

  • $120,000 for general improvements to the leased premises with an estimated useful life of 10 years.
  • $50,000 for office furniture and equipment with an estimated useful life of 10 years.

At December 31, 2005, Ames' intentions as to the exercise of the renewal option are uncertain. A full year's amortization of leasehold improvements is taken for calendar year two. In Ames' December 31, 2005 Balance Sheet, accumulated amortization should be:

  1. $10,000
  2. $15,000
  3. $17,000
  4. $21,250

$15,000

The appropriate amortization period for the leasehold improvements is eight years because renewal is uncertain. $120,000/8 = $15,000. This is the amount in accumulated amortization because the property has been leased only one year. The office furniture and equipment are not included in leasehold improvements because they belong to the lessee.

25

Which of the following characteristics relates to both accounting relevance and faithful representation?

  1. Free from error.
  2. Predictive value.
  3. Neutrality.
  4. Comparability.

Comparability.

Comparability is an enhancing characteristic, which relates to both relevance and faithful representation. 

26

According to the FASB Conceptual Framework, what does the concept of faithful representation in financial reporting include?

  1. Effectiveness.
  2. Certainty.
  3. Precision.
  4. Neutrality.

Neutrality.

Information is representationally faithful if it is neutral, complete, and free from error. 

27

ABC Co. was organized on July 15, 2004, and earned no significant revenues until the first quarter of 2007. During the period 2004-2006, ABC acquired plant and equipment, raised capital, obtained financing, trained employees, and developed markets.

In its financial statements as of December 31, 2006, ABC should defer all costs incurred during 2004-06,

  1. Net of revenues earned, which are recoverable in future periods.
  2. Net of revenues earned.
  3. Which are recoverable in future periods.
  4. Without regard to net revenues earned or recoverability in future periods.

Which are recoverable in future periods.

ABC is a development stage enterprise. Such enterprises are subject to the same accounting principles governing capitalization of costs as enterprises that have established themselves as on-going enterprises. Therefore, the amount of cost to be capitalized or deferred is the amount of cost that is recoverable in future periods.

28

Mr. & Mrs. Carson are applying for a bank loan and the bank has requested a personal statement of financial condition as of December 31, year 3.  Included in their assets at this date are the following:

  • 1,000 shares of Alden Corporation common stock purchased in year 3 at a cost of $50,000. The quoted market value of the stock was $75 per share on December 31, year 3.
  • A residence purchased in year 1 at a cost of $120,000.  Improvements costing $15,000 were made in year 2. Unimproved similar homes in the area are currently selling at approximately the same price levels as in year 1.

In the Carsons’ December 31, year 3 personal statement of financial condition, the above assets should be reported at a total amount of

  1. $170,000
  2. $185,000
  3. $195,000
  4. $210,000

$210,000

Per ASC Topic 274, assets are to be reported at estimated current values in a personal statement of financial condition. The current value of the investment in stock is $75,000 (1,000 shares × $75 per share). The current value of the residence can be estimated at $135,000. This consists of the cost of $120,000 (since similar unimproved homes are selling at the same price level which they were selling at in year 1) and the cost of improvements ($15,000). It can be assumed that the improvements will increase the value of the house by at least their cost. Therefore, the total amount is $210,000 (investment of $75,000 plus the house worth $135,000).

29

Multico is a securities dealer whose principal market is with other securities dealers. To take advantage of a perceived opportunity, on December 31, the end of its fiscal year, Multico acquired a financial asset in a market other than its principal market for $50,000. At that date, the identical instrument could be sold in Multico's principal market for $50,100 with a $200 transaction cost. Which of the following amounts would constitute fair value to Multico for the financial asset at December 31?

  1. $49,800
  2. $49,900
  3. $50,000
  4. $50,100

$50,100

Since fair value is based on an exit price, the amount at which Multico could have sold the asset in its principal market is its fair value to Multico. Since the asset could have been sold by Multico in its principal market for $50,100, that is its fair value to Multico. The transaction cost to execute the sale should not be deducted from the market price to get fair value.

Remember if Principal market = no transaction costs (but may consider transportation cost), and if NO PRINCIPAL market = consider the transaction costs but only for ascertaining the most advantageous market, then go with the full price of the investment as the FV.  

30

Inventory Turnover

COGS / Average Inventory

31

Sanni Co. had $150,000 in cash-basis pretax income for the year.  At the current year-end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances.  Compared to the accrual-basis method of accounting, Sanni’s cash-basis pretax income is

  1. Higher by $4,000
  2. Lower by $4,000
  3. Higher by $36,000
  4. Lower by $36,000

Higher by $36,000

Because accounts receivable decreased by $20,000, the cash received was $20,000 more than the accrual-basis sales.  Since accounts payable increased by $16,000 during the year, accrual-basis expenses were $16,000 more than cash payments.  Therefore, accrual-basis net income is equal to $114,000 ($150,000 – 20,000 – $16,000), and therefore, cash-basis pretax income is $36,000 ($150,000 – $114,000) higher than accrual-basis income.

32

On December 30, 2004, Solomon Co. had a current ratio greater than 1:1 and a quick ratio less than 1:1. 
On December 31, 2004, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?

  • Current ratio    
  • Quick ratio

  • Current ratio - INCREASE 
  • Quick ratio - DECREASE

Cash is both a current and a quick asset (an asset immediately available to pay debts). Accounts payable is a current liability. Thus, the numerator and denominator of both ratios have decreased. 
The current ratio was greater than 1.0 before the transaction. Therefore, the denominator decreased a greater percentage than the numerator causing the ratio to increase. 
The quick ratio was less than 1.0 before the transaction. Therefore, the numerator decreased a greater percentage than the denominator causing the ratio to decrease.

33

Which of the following would be reported as an investing activity in a company's statement of cash flows?

  1. Collection of proceeds from a note payable.
  2. Collection of a note receivable from a related party.
  3. Collection of an overdue account receivable from a customer.
  4. Collection of a tax refund from the government.

Collection of a note receivable from a related party.

Proceeds from a note payable is a financing activity.

Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity – the fact that the loan is in the form of a note implies that it is interest bearing.

34

In determining the fair value of an asset in the most advantageous market, the market based exit price should be adjusted for

  • Transaction Cost   
  • Transportation Cost  

  • Transaction Cost  - NO  
  • Transportation Cost - YES

In determining the fair value of an asset in the most advantageous market, the market based exit price would not be adjusted for transaction cost associated with executing the (hypothetical) transaction, but would be adjusted for transportation cost to get the asset to the principal or most advantageous market.

35

Which of the following is not a reason to prepare prospective financial information?

  1. To aid in considering a change in accounting or operations.
  2. To aid in preparation of the budget.
  3. To obtain external financing.
  4. To meet the requirements of GAAP.

To meet the requirements of GAAP.

The preparation of prospective financial information is not required by GAAP.

36

Tod Corp. wrote off $100,000 of obsolete inventory on December 31, 2005. The effect of this write-off was to decrease

  1. Both the current and acid-test ratios.
  2. Only the current ratio.
  3. Only the acid-test ratio.
  4. Neither the current nor the acid-test ratios.

Only the current ratio.

Inventory is a current asset but not a quick asset (assets that are readily converted to cash). The current ratio is current assets/current liabilities. Thus, the current ratio is reduced.

The quick ratio is quick assets/current liabilities. Thus, the quick ratio is unaffected.

37

Wright Company sells for cash major household appliance service contracts agreeing to service customers’ appliances for a 1-year, 2-year, or 3-year period.  Cash receipts from contracts are credited to unearned service contract revenues and this account had a balance of $1,440,000 at December 31, year 1, before year-end adjustment. Service contract costs are charged to service contract expense as incurred and this account had a balance of $360,000 at December 31, year 1. Outstanding service contracts at December 31, year 1, expire as follows:

  • During year 2 - $300,000
  • During year 3 - $450,000
  • During year 4 - $200,000

What amount should Wright report as unearned service contract revenues at December 31, year 1?

  1. $490,000
  2. $712,500
  3. $950,000
  4. $1,080,000

$950,000

This answer is correct. The amount reported in this liability account should be the total amount of outstanding service contracts at 12/31/Y1, or $950,000 ($300,000 + $450,000 + $200,000).  Wright’s 12/31/Y1 adjusting entry would reduce the liability account from $1,440,000 to $950,000. 

  • Dr. Unearned service contracts revenue $490,000 
    • Cr. Service contracts revenue $490,000

38

Esker Inc. specializes in real estate transactions other than retail land sales.  On January 1, year 1, Esker consummated a sale of property to Kame Ltd.  The amount of profit on the sale is determinable and Esker is not obligated to perform any additional activities to earn the profit.  Kame’s initial and continuing investments were adequate to demonstrate a commitment to pay for the property.  However, Esker’s receivable may be subject to future subordination. Esker should account for the sale using the

  1. Deposit method.
  2. Reduced profit method.
  3. Cost recovery method.
  4. Full accrual method.

Cost recovery method.

The problem states that the sale has been consummated and that Kame’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property. However, the fact that Esker’s receivable is subject to future subordination precludes recognition of the profit in full. Instead, the cost recovery method must be used to account for the sale.

The full accrual method may be used only if profit on the sale is determinable, the earning process is virtually complete, and all of the following:

  1. A sale is consummated.
  2. The buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property.
  3. The seller’s receivable is not subject to future subordination.
  4. The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is, in substance, a sale and does not have a substantial continuing involvement in the property.

Since Esker’s receivable is subject to future subordination, the full accrual method may not be used to account for the sale.

39

Northstar Co. acquired a registered trademark for $600,000. The trademark has a remaining legal life of five years, but can be renewed every 10 years for a nominal fee. Northstar expects to renew the trademark indefinitely. What amount of amortization expense should Northstar record for the trademark in the current year?

  1. $0
  2. $15,000
  3. $40,000
  4. $120,000

$0

When the intangible asset can be renewed indefinitely, and the company has the positive ability and intent to continuously renew, then the intangible asset is an indefinite life intangible. Indefinite life intangibles are not amortized, but are tested for impairment on an annual basis.

40

On January 1, 2000, Nobb Corp. signed a 12-year lease for warehouse space. Nobb has an option to renew the lease for an additional 8-year period on or before January 1, 2004.

During January 2002, Nobb made substantial improvements to the warehouse. The cost of these improvements was $540,000, with an estimated useful life of 15 years.

At December 31, 2002, Nobb intended to exercise the renewal option. Nobb has taken a full year's amortization on this leasehold.

In Nobb's December 31, 2002 Balance Sheet, the carrying amount of this leasehold improvement should be:

  1. $486,000
  2. $504,000
  3. $510,000
  4. $513,000

$504,000

The remaining lease term at the end of 2002 is nine years (the 12-year lease term began January 1, 2000). The eight-year option is added to the term at that point to yield a revised lease term of 17 years (9 + 8). Leasehold improvements are amortized over the shorter of lease term (17 years) or useful life (15 years) because leasehold improvements revert to the lessor.

Thus, the amortization of the leasehold improvements is $36,000 ($540,000/15). At the end of 2002, the carrying value of the leasehold improvement is $504,000 ($540,000-$36,000). A full year of amortization is warranted in 2002 because the improvements were completed in January.

41

A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?

  1. 30 days.
  2. 40 days.
  3. 45 days
  4. 60 days

 

40 days.

A large accelerated filer is a company with worldwide market value of outstanding voting and nonvoting common equity held by nonaffiliates of $700 million or more. A large accelerated filer must file its 10Q within 40 days after quarter end.

42

Kent Co., a division of National Realty, Inc., maintains escrow accounts and pays real estate taxes for National's mortgage customers. Escrow funds are kept in interest-bearing accounts. Interest, less a 10% service fee, is credited to the mortgagee's account and used to reduce future escrow payments.
Additional information follows:

  • Escrow accounts liability, 1 January, 2004 $700,000
  • Escrow payments received during 2004 $1.58mn
  • Real estate taxes paid during $1.72mn
  • Interest on escrow funds during 2004 $50,000

What amount should Kent report as escrow accounts liability in its December 31, 2004 balance sheet?

  1. $510,000
  2. $515,000
  3. $605,000
  4. $610,000

$605,000

The following equation is used to explain the changes in the escrow liability and the ending balance (31 December, 2004):

Beginning + Payments - Real estate + Interest - 10% (interest) = Ending 
Balance Received Tax Payments Balance

$700,000 + $1.58mn - $1.72mn + $50,000 - $5,000 = $605,000

The interest increases the liability, because it is an amount owed to the mortgagee. This debt is extinguished by crediting the receivable from the mortgagee. The 10% fee reduces the portion of the liability owing to interest.

43

A shoe retailer allows customers to return shoes within 90 days of purchase. The company estimates that 5% of sales will be returned within the 90-day period. During the month, the company has sales of $200,000 and returns of sales made in prior months of $5,000. What amount should the company record as net sales revenue for new sales made during the month?

  1. $185,000
  2. $190,000
  3. $195,000
  4. $200,000

$190,000

The effect of estimated returns is recognized in the month of sale. Net sales to be reported for the current month equal $200,000 less the returns expected on those sales (5% or $10,000), or $190,000. The actual returns granted in the current month on previous months' sales were recognized as reductions in net sales in those previous months.

44

Dee’s inventory and accounts payable balances at December 31, year 2, increased over their December 31, year 1, balances. Should these increases be added to or deducted from cash payments to suppliers to arrive at year 2 cost of goods sold?

  • Increase in inventory
  • Increase in accounts payable

  • Increase in inventory - Deducted from
  • Increase in accounts payable - Added to

Cash payments to suppliers are converted to CGS as follows:

  •     Cash payments to suppliers
  •  + Increase in AP
  • –  Increase in inventory
  •     Cost of Goods Sold

An increase in ending inventory represents the cost of items purchased during the period which remain unsold. Thus, the increase should be deducted from cash payments to suppliers. An increase in AP indicates that certain items purchased during the period have not yet been paid for and are not included in cash payments. Since these represent unrecorded purchases, the increase must be added to cash payments to suppliers to arrive at CGS.

Increase in inventory means purchases exceeded cost of goods sold and increase in AP means there was less cash payments to vendors than amount of purchases.

45

On January 1, 2004, Bay Co. acquired a land lease for a 21-year period with no option to renew.

The lease required Bay to construct a building in lieu of rent. The building, completed on January 1, 2005, at a cost of $840,000, will be depreciated using the straight-line method. At the end of the lease, the building's estimated market value will be $420,000.

What is the building's carrying amount in Bay's December 31, 2005 Balance Sheet?

  1. $798,000
  2. $800,000
  3. $819,000
  4. $820,000

$798,000

The building is a leasehold improvement because it reverts to the lessor at the end of the lease. The residual value belongs to the lessor and is not relevant to the lessee. The building was completed at the beginning of the second year of the lease. Therefore, the total cost to the lessee of $840,000 is amortized over 20 years, not 21.

The carrying value of the leasehold improvement at the end of 2005, the first year of the building's life but the second year of the lease, is $798,000 = $840,000(19/20).

46

In determining the fair value of a nonfinancial asset, assessing the highest and best use of the asset must take into account all but which one of the following?

  1. What is physically possible.
  2. What is financially feasible.
  3. How the reporting entity would use the asset.
  4. What is legally permissible.

How the reporting entity would use the asset.

In determining the fair value of a nonfinancial asset, how the reporting entity would use the asset would not be taken into account in assessing the highest and best use of the asset. The highest and best use is based on use of the asset by market participants, not by the reporting entity.

47

The SEC defines a foreign private issuer as any issuer other than a foreign government, except an issuer that where more than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S. and what other condition?

  1. The business of the issuer is administered principally in the foreign country.
  2. More than 50% of the assets of the issuer are located in the foreign country.
  3. The majority of its executive officers or directors are U.S. citizens or residents.
  4. All of the above

The majority of its executive officers or directors are U.S. citizens or residents.

A foreign private issuer is any foreign issuer other than a foreign government, except an issuer that meets the following conditions:

  • More than 50% of the outstanding voting securities are directly or indirectly owned by residents of the U.S., and
  • Any of the following:
  1. The business of the issuer is administered principally in the U.S.
  2. More than 50% of the assets of the issuer are located in the U.S.
  3. The majority of its executive officers or directors are U.S. citizens or residents.

48

Lane Co., which began operations on January 1, year 1, appropriately uses the installment method of accounting. The following information pertains to Lane’s operations for year 1:

  • Installment sales $1,000,000
  • Regular sales $600,000
  • Cost of installment sales $500,000
  • Cost of regular sales $300,000
  • General and administrative expenses $100,000
  • Collections on installment sales $200,000

The deferred gross profit account in Lane’s December 31, year 1 balance sheet should be

  1. $150,000
  2. $320,000
  3. $400,000
  4. $500,000

$400,000

Under the installment method, gross profit is deferred at the time of sale and is recognized by applying the gross profit rate to subsequent cash collections.  At the time of sale, gross profit of $500,000 is deferred ($1,000,000 – $500,000).  The gross profit rate is 50% ($500,000 ÷ $1,000,000).  Since year 1 collections on installment sales were $200,000, gross profit of $100,000 (50% × $200,000) is recognized in year 1.  This recognition of gross profit would decrease the deferred gross profit account to a 12/31/Y1 balance of $400,000 ($500,000 – $100,000). Note that regular sales, cost of regular sales, and general and administrative expenses do not affect the deferred gross profit account.

49

If a firm changes the valuation approach used to determine fair value, how would the amount of change in fair value resulting from the change in the valuation approach be reported?

  1. As a change in accounting principle.
  2. As an adjustment to beginning retained earnings of the period of change in approach.
  3. As a change in accounting estimate.
  4. As gain on the income statement for the period of change in approach.

As a change in accounting estimate.

The amount of change in fair value resulting from a change in the valuation approach used to determine fair value is reported as a change in accounting estimate. That means that the amount of the change, like the change in fair value resulting from market forces, will be reported in current income (as income from continuing operations).

50

Which of the following is true regarding the comparison between managerial and financial accounting?

  1. Managerial accounting is generally more precise.
  2. Managerial accounting has a past focus and financial accounting has a future focus.
  3. The emphasis on managerial accounting is relevance and the emphasis on financial accounting is timeliness.
  4. Managerial accounting need not follow Generally Accepted Accounting Principles (GAAP), while financial accounting must follow them.

Managerial accounting need not follow Generally Accepted Accounting Principles (GAAP), while financial accounting must follow them.

Managerial accounting is for internal use, and as such, does not follow GAAP. Financial accounting is for external users and must follow GAAP.

51

According to the Private Company Decision Making Framework, which of the following is not a potential differential factor between public business entities and private companies potentially necessitating the need for alternative private company guidance?

  1. Number of company investments.
  2. Number of primary users.
  3. Accounting resources.
  4. Ownership and capital structure.

Number of company investments.

Potential differential factors between public business entities and private companies include:

  • number of primary users and their access to management;
  • investment strategies of primary users;
  • ownership and capital structure;
  • accounting resources and
  • learning about new financial reporting guidance not number of subsidiaries.

52

A company recently acquired a copyright that now has a remaining legal life of 30 years. The copyright initially had a 38-year useful life assigned to it. An analysis of market trends and consumer habits indicated that the copyrighted material will generate positive cash flows for approximately 25 years. What is the remaining useful life, if any, over which the company can amortize the copyright for accounting purposes?

  1. 0 years.
  2. 25 years
  3. 30 years
  4. 38 years

25 years

This copyright has a definite life; the question is what is the length of that life? The life assigned to the intangible asset is the shorter of its legal and useful life. The useful life is shorter than the legal life, so this copyright is amortized over 25 years.

53

On January 1, 2001, Sip Co. signed a five-year contract enabling it to use a patented manufacturing process beginning in 2001.

A royalty is payable for each product produced, subject to a minimum annual fee. Any royalties in excess of the minimum will be paid annually. On the contract date, Sip prepaid a sum equal to two years' minimum annual fees. In 2001, only the minimum fees were incurred.

The royalty prepayment should be reported in Sip's December 31, 2001, financial statements as:

  1. An expense only.
  2. A current asset and an expense.
  3. A current asset and noncurrent asset.
  4. A noncurrent asset.

A current asset and an expense.

At the end of 2001, 1/2 of the prepayment is recognized as an expense. The minimum fee was incurred in 2001 equaling 1/2 of the prepayment amount. Sip has received the benefit of 1/2 of prepayment amount. The other 1/2 is applied to 2002 and allows Sip to use the patent in that year. This amount had future value as of 12/31/01. That future value is expected to expire at the end of 2002 and, thus, is classified as a current asset at the end of 2001. Additional use in 2002 beyond the minimum will be paid in that year.

54

On January 15, 2008, Able Co. made a significant investment in the debt securities of Baker Co., which it intends to hold until the debt matures. Able's fiscal year-end is December 31. If Able Co. intends to measure and report its investment in Baker Co. debt securities at fair value as permitted by FASB #159, "The Fair Value Option... ", on which one of the following dates must Able elect to implement the fair value option?

  1. January 15, 2008
  2. January 31, 2008
  3. March 31, 2008
  4. December 31, 2008

January 15, 2008

If Able Co. intends to elect to implement the fair value option for its investment in Baker's debt, it must make its election on the date it first recognizes the investment, which is January 15, 2008.

55

On December 31, year 1, Moon, Inc. authorized Luna Co. to operate as a franchisee for an initial franchise fee of $100,000. Luna paid $40,000 on signing the agreement and signed an interest-free note to pay the balance in three annual installments of $20,000 each, beginning December 31, year 2.  On December 31, year 1, the present value of the note, appropriately discounted, is $48,000.  Services for the initial fee will be performed in year 2. In its December 31, year 1 balance sheet, what amount should Moon report as unearned franchise fees?

  1. $0
  2. $48,000
  3. $88,000
  4. $100,000

$88,000

Franchise fee revenue is recognized when all material services have been substantially performed by the franchiser. Substantial performance means that the franchiser has performed substantially all of the required initial services and has no remaining obligation to refund any cash received. As of December 31, year 1, the date the agreement was signed, no services have been performed. Therefore, this answer is correct because the entire $88,000 must be recognized as unearned franchise fees in the December 31, year 1 balance sheet.

56

The following information is available for Bart Company for year 1:

  • Disbursements for purchases $580,000
  • Increase in trade accounts payable $50,000
  • Decrease in merchandise inventory $20,000

Cost of goods sold for year 1 was?

  1. $650,000
  2. $610,000
  3. $550,000
  4. $510,000

$650,000

This answer is correct. The basic cost of goods sold formula is:

Beg. inv. + Net Purchases – End. inv.  = CGS

To compute cost of goods sold from the information given, cash paid for purchases must be adjusted for increases (decreases) in both accounts payable and merchandise inventory.  Cash payments for purchases during year 1 were $580,000. In addition, accounts payable increased by $50,000, indicating that total purchases exceeded cash payments for purchases by $50,000.  Merchandise inventory decreased by $20,000, which means beginning inventory exceeded ending inventory by $20,000.  This decrease in inventory must be added to cash payments for purchases to compute the cost of goods sold of $650,000.
 

  • Cash paid for purchases $580,000
  • + Increase in AP $50,000
  • + Decrease in inv $20,000
  • Cost of goods sold $650,000

57

Based on 2000 sales of compact discs recorded by an artist under a contract with Bain Co., the artist earned $100,000 after an adjustment of $8,000 for anticipated returns.
In addition, Bain paid the artist $75,000 in 2000 as a reasonable estimate of the amount recoverable from future royalties to be earned by the artist.

What amount should Bain report in its 2000 Income Statement for royalty expense?

  1. $100,000
  2. $108,000
  3. $175,000
  4. $183,000

 

$100,000

The net amount earned by the artist is also the royalty expense to the firm. Royalty expense is recognized on the basis of the sales of the CD. Adjustments to the final amount earned for 2000, after all return information is known, will be treated as an adjustment to royalty expense in 2001. New information in 2001 will require a change in estimate, not retroactive application. The $100,000 amount is the best estimate of the royalty cost to Bain in 2000 that will ultimately be paid on 2000 sales.

58

The purpose of IASB's Framework for the preparation and presentation of financial statements includes all of the following except:

  1. Assist users of financial statements in interpreting the information contained in financial statements that are prepared in conformity with IFRSs.
  2. Assist national standard-setting bodies in developing national standards.
  3. Assist the IASB in the development of future IFRSs and in its review of existing IFRSs.
  4. Assist the IASB in enforcing regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs.

Assist the IASB in enforcing regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs.

Remember that the IASB has no enforcement authority. The enforcement is carried out by regulators, such as the SEC in the U.S., Central Banks, and governmental authorities. As such, the purpose of the IASB's Framework is not to assist in enforcing regulations, accounting standards, and procedures but, rather, to assist in promoting the harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative treatments permitted by IFRSs. IASB Framework, para. 1.

59

According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on

  1. The need for conservatism.
  2. Reporting on management’s stewardship.
  3. Generally accepted accounting principles.
  4. The needs of the users of the information.

The needs of the users of the information.

Per SFAC 8, the objectives of financial reporting focus on providing present and potential investors with information useful in making investment decisions. Financial statement users do not have the authority to prescribe the data they desire; therefore, they must rely on external financial reporting to satisfy their information needs.

60

According to the IASB Framework for the Preparation and Presentation of Financial Statements, the qualitative characteristic of faithful representation includes

  1. Timeliness, predictive value, and feedback value.
  2. Neutrality, completeness and free from error.
  3. Predictive value, confirmatory value, and materiality.
  4. Comparability and consistency.

Neutrality, completeness and free from error.

The IASB Framework for the Preparation and Presentation of Financial Statements has converged with the FASB’s SFAC 8.  The concept of faithful representation, includes completeness, neutrality, and free from error.

61

Weaver Company sells magazine subscriptions for a 1-year, 2-year, or 3-year period.  Cash receipts from subscribers are credited to magazine subscriptions collected in advance, and this account had a balance of $1,700,000 at December 31, year 1.  Information for the year ended December 31, year 2, is as follows:

  • Cash receipts from subscribers $2,100,000
  • Magazine subscriptions revenue (credited at 12/31/Y2) $1,500,000
  • In its December 31, year 2 balance sheet, what amount should Weaver report as the balance for magazine subscriptions collected in advance?
  1. $1,400,000
  2. $1,900,000
  3. $2,100,000
  4. $2,300,000

$2,300,000

The solutions approach is to set up a T- account for the liability.
As receipts are collected, the liability is credited to record the additional subscriptions owed to customers. In addition, the liability is decreased as revenue from the subscriptions is earned.  Based upon the information given, Weaver should report $2,300,000 of subscriptions collected in advance at December 31, year 2.

62

According to the installment method of accounting, the gross profit on an installment sale is recognized in income

  1. On the date of sale.
  2. On the date the final cash collection is received.
  3. After cash collections equal to the cost of sales have been received.
  4. In proportion to the cash collections received.

In proportion to the cash collections received.

The installment method of recognizing revenue is appropriate only when "collection of the sale price is not reasonably assured." Under the installment method, gross profit is deferred to future periods and recognized proportionately to collection of the receivables.

Revenue is recognized as cash is collected.  Thus, revenue recognition takes place at the point of cash collection rather than the point of sale.  Installment sales accounting can only be used where “collection of the sale price is not reasonably assured” (ASC Topic 605) (APB 10).

Under the installment sales method, gross profit is deferred to future periods and recognized proportionately to collection of the receivables. Installment receivables and deferred gross profit accounts must be kept separate by year, because the gross profit rate usually varies from year to year.

63

Conceptually, interim financial statements can be described as emphasizing:

  1. Timeliness over faithful representation.
  2. Faithful representation over relevance.
  3. Relevance over comparability.
  4. Comparability over neutrality.

Timeliness over faithful representation.

Interim reporting emphasizes timeliness over faithful representation. Interim reports are generally more aggregate and reflect estimates that are of a more approximate nature than those found in annual reports. The objective is to provide reasonable information in a timely fashion, rather than exact information. The cost to provide the latter would often be prohibitive on a quarterly basis.

64

Acounts Receivable Turnover

Net Credit Sales / Average Accounts Receivable

65

How would the proceeds received from the advance sale of nonrefundable tickets for a theatrical performance be reported in the seller’s financial statements before the performance?

  1. Revenue for the entire proceeds.
  2. Revenue to the extent of related costs expended.
  3. Unearned revenue to the extent of related costs expended.
  4. Unearned revenue for the entire proceeds.

Unearned revenue for the entire proceeds.

Per SFAC 5, revenue should not be recognized until earned. Revenues are generally earned when the product is delivered or services are rendered to customers. When a sale or cash receipt (or both) takes place prior to the delivery of the product or performance of the service, as in this case, the revenues should be earned as delivery/performance takes place. Since the entire proceeds in this problem are for the advance sale of tickets, they should be reported as unearned revenue in the seller’s financial statements before the performance.

66

Which regulation governs the form and content of financial statement disclosures?

  1. Regulation S-X.
  2. Sarbanes Oxley.
  3. Regulation S-K.
  4. Regulation S-Q.

Regulation S-X.

Regulation S-X governs the form and content of financial statements and financial statement disclosures.

67

Mill Construction Co. uses the percentage-of-completion method of accounting. During 2005, Mill contracts to build an apartment complex for Drew for $20mn. Mill estimates that total costs would amount to $16mn over the period of construction.
In connection with this contract, Mill incurs $2mn of construction costs during 2005. Mill bills and collects $3mn from Drew in 2005.

What amount should Mill recognize as gross profit for 2005?

  1. $250,000
  2. $375,000
  3. $500,000
  4. $600,000

$500,000

The project is 12.5% complete at the end of 2005 ($2mn/$16mn). Total gross profit through the end of 2005 is therefore $500,000 [= .125($20mn - $16mn)].

The $500,000 amount is the proportion of completion applied to the total contract profit of $4mn. 2005 is the first year of construction; therefore no gross profit from previous years is subtracted. The entire $500,000 gross profit is recognized in 2005.

68

In the determination of fair value for GAAP purposes, which one of the following is not a valuation technique or approach specified in ASC 820, "Fair Value Measurement"?

  1. Income approach.
  2. Cost approach.
  3. Expense approach.
  4. Market approach.

Expense approach.

The expense approach is not one of the approaches for the determination of fair value specified in ASC 820; it is an irrelevant distracter in this question.

69

The following data pertain to Ruhl Corp.'s operations for the year ended December 31, 2005:

  • Operating income $800,000
  • Interest expense $100,000
  • Income before income tax $700,000
  • Income tax expense $210,000
  • Net income $490,000

The times interest earned ratio is

  1. 8.0 to 1.
  2. 7.0 to 1.
  3. 5.6 to 1.
  4. 4.9 to 1.

8.0 to 1

The times interest earned ratio is: (income before interest expense and income tax/interest expense). 
For Ruhl, this ratio is: $800,000/$100,000 = 8. This means that the firm has earnings that would support interest eight times the current level. In other words, the firm could pay its current level of interest eight times. 
If interest expense were $800,000, net income would be zero and no tax would be due. $800,000 of interest could be paid from resources earned in the current period.

70

Current Ratio

Current Assets / Current Liabilities

Positive WC is a ratio > 1

71

Baker Co. has a franchise restaurant business. On January 15 of the current year, Baker charged an investor a fran­chise fee of $65,000 for the right to operate as a franchisee of one of Baker’s restaurants. A cash payment of $25,000 towards the fee was required to be paid to Baker during the current year.  Four subsequent annual payments of $10,000 with a present value of $34,000 at the current market interest rate represent the balance of the fee which is expected to be collected in full.  The initial cash payment is nonrefundable and no future services are required by Baker. What amount should Baker report as franchise revenue during the current year?

  1. $0
  2. $25,000
  3. $59,000
  4. $65,000

$59,000

Revenue on a franchise agreement should be recognized when the franchisor has substantially performed all material services and conditions, and collectibility is reasonably assured. Baker should recognize $59,000 in revenue: the initial cash payment ($25,000) plus the present value of the future cash payments ($34,000).

72

A company owns a financial asset that is actively traded on two different exchanges (market A and market B). There is no principal market for the financial asset. The information on the two exchanges is as follows

Quoted price of asset, Transaction costs

Market A $1,000, TC = $75

Market B $1,050, TC = $150

What is the fair value of the financial asset?

  1. $900
  2. $925
  3. $1,000
  4. $1,050

$1,000

The fair value of the financial asset is $1,000, the quoted price in the most advantageous market, but without adjusting that price for transaction costs. Since there is no principal market for the financial asset, the most advantageous market must be used to determine fair value. The most advantageous market is the market that maximizes the amount that would be received to sell the asset (or minimizes the amount that would be paid to transfer a liability), after taking into account transaction costs and transportation costs. Thus, the most advantageous market is Market A, determined as:

Market A, Market B

Quoted price of asset $1,000, $1,050

Transaction cost ($75), ($150)

Net Proceeds $925, $900

Even though transaction costs are considered in determining the most advantageous market, the price in the most advantageous (or principal) market used to measure the fair value of the asset (or liability) is not adjusted for transaction costs [ASC 820-10-35-9B]. Therefore, the quoted price of the asset in the most advantage market, unadjusted for the transaction costs, is fair value.

73

In 2000, Chain, Inc. purchased a $1,000,000 life insurance policy on its president, of which Chain is the beneficiary. Information regarding the policy for the year ended December 31, 2005, follows:

  • Cash surrender value, 1/1/05 $87,000
  • Cash surrender value, 12/31/05 $108,000
  • Annual advance premium paid 1/1/05 $40,000

During 2005, dividends of $6,000 were applied to increase the cash surrender value of the policy. What amount should Chain report as life insurance expense for 2005?

  1. $40,000
  2. $25,000
  3. $19,000
  4. $13,000

$19,000

In computing life insurance expense, the increase in cash surrender value is subtracted from the annual premium because the net cost to the firm is the premium less the increase in that investment. The investment is property of the insured firm.

The cash surrender value (an investment account) increased $21,000 during 2005 ($108,000-$87,000). This increase is treated as a direct reduction in the current year's insurance premium. Therefore, insurance expense is $19,000 ($40,000-$21,000) for 2005.

What makes this question difficult is realizing that the dividends are not treated as a separate revenue; rather, they are treated as an offset against insurance expense. The reason is that the dividends are directly related to the policy. The investment aspect of whole life insurance is an integral part of the life insurance policy.

74

During the period when an enterprise is under the direction of a particular management, its financial statements will directly provide information about:

  1. Both enterprise performance and management performance.
  2. Management performance but does not directly provide information about enterprise performance.
  3. Enterprise performance but not directly provide information about management performance.
  4. Neither enterprise performance nor management performance.

Enterprise performance but not directly provide information about management performance.

The financial statements provide a wealth of information about the performance and financial position of the enterprise, but they do not directly allow an evaluation of management. There are too many factors that affect the firm's performance to be able to single out management's contribution (or lack of it). Many factors interact to determine the performance of the enterprise, one of them being management's performance. Also, for example, current enterprise performance is affected by the past actions of managers that may no longer be with the enterprise.

75

Compared to its 2004 cash-basis net income, Potoma Co.'s 2004 accrual-basis net income increased when it:

  1. Declared a cash dividend in 2003 that it paid in 2004.
  2. Wrote off more accounts receivable balances than it reported as uncollectible accounts expense in 2004.
  3. Had lower accrued expenses on December 31, 2004, than on January 1, 2004.
  4. Sold used equipment for cash at a gain in 2004.

Had lower accrued expenses on December 31, 2004, than on January 1, 2004.

If the accrued expenses account (a current liability, often called accrued expenses payable) decreased during 2004, then a greater amount of cash was paid for those expenses in 2004 than were accrued in 2004. This would cause cash-basis net income to be less than accrual-basis net income. Cash-basis net income reflects expenses paid; accrual-basis net income reflects expenses recognized (accrued).

76

What effect would the sale of a company's trading securities at their carrying amounts for cash have on each of the following ratios?

  1. Current ratio    
  2. Quick ratio

No Effect on Both.

The current ratio equals current assets divided by current liabilities. The quick ratio equals quick assets divided by current liabilities. Quick assets include cash, cash equivalents, trading securities, accounts receivable and other current assets readily convertible to cash. Quick assets exclude inventories and prepaids.

Trading securities are included in both current assets and quick assets because they are, by definition, immediately marketable. The sale of trading securities at book value has no effect on current assets or quick assets because the cash received equals the reduction in the trading securities account. Thus, neither ratio is affected by such a sale.

77

The following information pertains to a sale of real estate by Ryan Co. to Sud Co. on December 31, year 1:

  • Carrying amount $2,000,000
  • Sales price:  
    • Cash $300,000 
    • Purchase money mortgage2,700,000
  • SP = $3,000,000

The mortgage is payable in nine annual installments of $300,000 beginning December 31, year 2, plus interest of 10%.  The December 31, year 2 installment was paid as scheduled, together with interest of $270,000. Ryan uses the cost recovery method to account for the sale.  What amount of income should Ryan recognize in year 2 from the real estate sale and its financing?

  1. $570,000
  2. $370,000
  3. $270,000
  4. $0

$0

Under the cost recovery method no profit of any type is recognized until the cumulative receipts (principal and interest) exceed the cost of the asset sold.  This means that the entire gross profit ($3,000,000 – $2,000,000 = $1,000,000) and the year 2 interest received ($270,000) will be deferred until cash collections exceed $2,000,000. Therefore, no income is recognized in year 2.

78

Which of the following is an example of the expense recognition principle of associating cause and effect?

  1. Allocation of insurance cost.
  2. Sales commissions.
  3. Depreciation of fixed assets.
  4. Officers’ salaries.

Sales commissions.

Sales commissions are recognized as an expense on the basis of a presumed direct association with the related sales revenue (SFAC 5).

Under accrual accounting, expenses are recognized as related revenues are recognized, that is, (product) expenses are matched with revenues.  Some (period) expenses, however, cannot be associated with particular revenues. These expenses are recognized as incurred.

  1. Product costs are those which can be associated with particular sales (e.g., cost of sales). Product costs attach to a unit of product and become an expense only when the unit to which they attach is sold.  This is known as associating “cause and effect.”
  2. Period costs are not particularly or conveniently assignable to a product.  They become expenses due to the passage of time by
    1. Immediate recognition if the future benefit cannot be measured (e.g., advertising)
    2. Systematic and rational allocation if benefits are produced in certain future periods (e.g., asset depreciation)

79

Under Statement of Financial Accounting Concepts 8, completeness is an ingredient of

  • Relevance 
  • Faithful representation

Faithful representation - ONLY

Information is representationally faithful if it is reasonably free from error and bias, and complete.

80

On December 30, Devlin Co. sold goods to Jensen Co. for $10,000, under an arrangement in which (1) Jensen has an unlimited right of return and (2) Jensen’s obligation to pay Devlin is contingent upon Jensen’s reselling the goods.  Past experience has shown that Jensen ordinarily resells 60% of goods and returns the other 40%.  What amount should Devlin include in sales revenue for this transaction on its December 31 income statement?

  1. $10,000
  2. $6,000
  3. $4,000
  4. $0

$0

When the right of return exists, a seller may only recognize revenue when the buyer is obligated to pay the seller, and the obligation is not contingent on the resale of the product. Because Jensen’s obligation to repay is contingent upon Jensen reselling the goods, Jensen cannot recognize revenue in its December 31 income statement.

81

A company is required to file quarterly financial statements with the United States Securities and Exchange Commission on Form 10-Q. The company operates in an industry that is not subject to seasonal fluctuations, which could have a significant impact on its financial condition. In addition to the most recent quarter end, for which of the following periods is the company required to present Balance Sheets on Form 10-Q?

  1. The end of the corresponding fiscal quarter of the preceding fiscal year.
  2. The end of the preceding fiscal year and the end of the corresponding fiscal quarter of the preceding fiscal year.
  3. The end of preceding fiscal year.
  4. The end of the preceding fiscal year and the end of the prior two fiscal years.

The end of preceding fiscal year.

The Balance Sheet for the end of the preceding fiscal year would have been the last audited Balance Sheet. This Balance Sheet is presented along with the current fiscal quarter.

82

Compared to the accrual basis of accounting, the cash basis of accounting overstates income by the net increase during the accounting period of the

  • Accounts receivable
  • Accrued expenses payable  

NO and YES.

An increase in accounts receivable reflects recognized but uncollected sales. The accrual method recognizes these sales as earnings, causing income to exceed cash-basis income for such sales. Thus cash-basis income is understated relative to accrual-basis accounting. The opposite is true for an increase in accrued expenses. The increase in the liability reflects recognized but unpaid expenses. The accrual method recognizes these expenses in earnings, causing income to decrease relative to cash-basis income. Thus, cash-basis income is overstated, relative to accrual-basis accounting.

83

On January 2, 2004, Beal, Inc. acquired a $70,000 whole-life insurance policy on its president. The annual premium is $2,000. The company is the owner and beneficiary. 
Beal charged officer's life insurance expense as follows:

  • 2004 $2,000
  • 2005 $1,800
  • 2006 $1,500
  • 2007 $1,100
  • Total $6,400

In Beal's December 31, 2007 Balance Sheet, the investment in cash surrender value should be:

  1. $0
  2. $1,600
  3. $6,400
  4. $8,000

$1,600

The $1,600 ending cash surrender value is the difference between the total premiums paid ($8,000 = 4 x $2,000) and the total amount charged to insurance expense ($6,400). An increasing portion of the premiums on life insurance are allocated to the investment feature of life insurance each year.

84

Times Interest Earned Ratio

(Net Income + Interest Expense + Income Tax Expense) / Interest Expense

measures ability of current earnings to cover interests costs for the period.  

85

The FASB has maintained that:

  1. The interests of the reporting firms will be a primary consideration when developing new GAAP.
  2. GAAP should have little or no cost of compliance.
  3. New GAAP should be neutral and not favor any particular reporting objective.
  4. GAAP should result in the most conservative possible financial statements.

New GAAP should be neutral and not favor any particular reporting objective.

One of the objectives of the FASB in setting standards is to develop rules that are unbiased. FASB statements generally do not reflect any reporting bias.

For example, the requirement to expense all research and development costs is uniform across all firms and does not favor one firm over another.

86

Kelly Corp. barters with Ace Corporation for goods that are similar in nature and value. The value of the goods was $1,000.  The cost of the goods was $400.  If Kelly uses IFRS to prepare financial statements, what amount should Kelly recognize as income?

  1. $1,000.
  2. $0.
  3. $400.
  4. $600.

$0

If the goods are similar in nature and value, then no income or expense is recognized.

Barter transactions are not recognized if the exchanged goods are similar in nature and value.  If the goods are dissimilar, revenue is recognized at fair value of the goods received.  If the fair value of the goods received cannot be measured, revenue is recognized at the fair value of goods or services given up.

87

According to the conceptual framework, the quality of information that helps users increase the likelihood of correctly forecasting the outcome of past or present events is called:

  1. Confirmatory value.
  2. Predictive Value.
  3. Representational faithfulness.
  4. Faithful representation.

Predictive Value.

Predictive value is the ingredient that helps users increase the likelihood of forecasting the outcome of events. Financial statement information is useful if it helps users make decisions about investing and extending credit. These decisions involve predictions of a firm's future financial performance, position, and cash flows.

88

Giaconda, Inc. acquires an asset for which it will measure the fair value by discounting future cash flows of the asset. Which of the following terms best describes this fair value measurement approach?

  1. Market.
  2. Income.
  3. Cost.
  4. Observable inputs.

Income.

The income approach to fair value measurement of an asset measures fair value by converting future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.

89

A patent, purchased in year 1 and being amortized over a 10-year life, was determined to be worthless in year 5. The write-off of the asset in year 5 is an example of which of the following principles?

  1. Associating cause and effect.
  2. Immediate recognition.
  3. Systematic and rational allocation.
  4. Objectivity.

Immediate recognition.

Per SFAC 5, the principle of immediate recognition requires that items carried as assets in prior periods that are discovered to be impaired in value be charged to expense (e.g., a patent that is determined to be worthless).

Losses = When future economic benefits are reduced or eliminated

When economic benefits are consumed during a period, the expense may be recognized by matching (such as cost of goods sold), immediate recognition (such as selling and administrative salaries), or systematic and rational allocation (such as depreciation).

90

Bucca Warehousing Corporation bought a building at auction on June 30, Year 1, for $1,000,000. On July 2, Year 1, before occupying the building, Bucca sold it to a triple-A rated company for $1,200,000.  Bucca received a cash down payment of $300,000 and a first mortgage note at the market rate of interest for the balance. No additional payments were required until Year 2. On September 1, Year 1, an independent appraiser valued the property at $1,500,000. On its Year 1 income tax return, Bucca reported the sale on the installment basis. How much gain should Bucca recognize in its income statement for the year ended December 31, Year 1?

  1. $0
  2. $50,000
  3. $200,000
  4. $300,000

$200,000

The installment method of recognizing revenue is not acceptable for financial reporting purposes unless the circumstances are such that the collection of the sales price is not reasonably assured. Since the property was sold to a triple-A rated company and the value of the property is appreciating, collection can be assumed to be reasonably assured. Therefore, the entire gain should be recognized for financial reporting purposes at the date of sale:
 

Sales price – Cost of building = Gain recognized

$1,200,000 – $1,000,000 = $200,000

91

According to the FASB Conceptual Framework, which of the following situations violates the concept of faithful representation?

  1. Financial statements were issued 9 months late.
  2. Report data on segments having the same expected risks and growth rates to analysts estimating future profits.
  3. Financial statements included property with a carrying amount increased to management’s estimate of market value.
  4. Management reports to stockholders regularly refer to new projects undertaken, but the financial statements never report project results.

Financial statements included property with a carrying amount increased to management’s estimate of market value.

Faithful representation is that the information depicts what it purports to represent.  It has three subcomponents:  completeness, neutrality, and free from error.  Neutrality means that information should not be prepared or reported in such a way as to obtain a predetermined result. Also, the information should be free from bias. This answer is correct because management’s estimate violates the characteristics of neutrality and verifiability. Property should be valued at its carrying amount on the financial statements, not management’s estimates of market value.  Completeness requires that information is presented or depicted in such a way that users can understand the item being depicted free from error is that no errors or omissions in the information are reported.  

92

When would a company use the installment sales method of revenue recognition?

  1. When collectability of installment accounts receivable is reasonably predictable.
  2. When repossessions of merchandise sold on the installment plan may result in a future gain or loss.
  3. When installment sales are material, and there is no reasonable basis for estimating collectability.
  4. When collection expenses and bad debts on installment accounts receivable are deemed to be immaterial.

When installment sales are material, and there is no reasonable basis for estimating collectability.

The installment sales method of revenue recognition is used when sales are material, and the collection of the sales price is not reasonably assured.

93

A retail store received cash and issued gift certificates that are redeemable in merchandise. The gift certificates lapse 1 year after they are issued. How would the deferred revenue account be affected by each of the following transactions?

  • Redemption of certificates
  • Lapse of certificates

  • Redemption of certificates - DECREASE
  • Lapse of certificates - DECREASE

This answer is correct. At the time the gift certificates were issued, the following entry was made:

  • Cashxx 
  •       Deferred revenue xx

Upon redemption of the certificates, the obligation becomes satisfied and the revenue is earned.  Similarly, as the certificates expire, the store is no longer under any obligation to honor the certificates and the deferred revenue should be taken into income.  In both instances, the deferred revenue account must be reduced (debited) to reflect the earning of revenue. This is done through the following entry:

  • Deferred revenuexx 
  •       Revenue xx

94

Even though the SEC delegates the creation of accounting standards to the private sector, the SEC frequently comments on accounting and auditing issues. The main pronouncements published by the SEC are:

  1. Federal Reporting Updates (FRU).
  2. Financial Reporting Releases (FRR).
  3. Staff Auditing Bulletins (SAB).
  4. Accounting Principles Opinions (APO).

Financial Reporting Releases (FRR).

The main pronouncements published by the SEC are the Financial Reporting Releases (FRR) and the Staff Accounting Bulletins (SAB).

Another pronouncement type is Accounting and Auditing Enforcement Releases (AAER).

95

In which one of the following circumstances is the entry price to acquire an asset least likely to represent fair value of the asset?

  1. An investment security is acquired for cash through a public market.
  2. A machine is acquired from a wholesaler by giving an interest-bearing note.
  3. A significant amount of raw material inventory is acquired for cash from a bankrupt supplier.
  4. Land and a building are acquired in the open market by giving a mortgage to a lender.

A significant amount of raw material inventory is acquired for cash from a bankrupt supplier.

Since the raw material inventory was acquired from a supplier in bankruptcy, it is likely that the transaction occurred when the seller was under duress. Therefore, it is likely that the price paid (an entry price) does not represent fair value - an exit price at which the inventory could be sold by a seller not under financial duress.

96

A contractor recognizes $42,000 of gross profit on a contract at the end of year one of the contract under the percentage-of-completion method. At the end of year two, the gross profit to be recognized for both years together is $34,000. The total anticipated gross profit on the project estimated at the end of year two is $78,000. What amount of gross profit is to be recognized for year two alone?

  1. $78,000
  2. $34,000
  3. $8,000
  4. $0

$8,000

This is an example of a single-period loss on a profitable contract. The loss for year two is computed as: $34,000 gross profit through year two - $42,000 gross profit year one = - $8,000 single-period loss. The loss "reverses" $8,000 of the $42,000 gross profit recognized in year one.

97

According to the IASB Framework, which of the following is an essential characteristic of an asset?

  1. The claims to an asset's benefits are legally enforceable.
  2. An asset is tangible.
  3. An asset is obtained at a cost.
  4. An asset provides future benefits.

An asset provides future benefits.

According to the IASB's Framework, an asset is defined as "a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity." IASB Framework, para. 49.

98

Days in Inventory

365 / Inventory Turnover = average number of days inventory is sold or used

99

Star Co. leases a building for its product showroom. The 10-year non-renewable lease will expire on December 31, 2007. In January 2002, Star redecorated its showroom and made leasehold improvements of $48,000. The estimated useful life of the improvements is 8 years. Star uses the straight-line method of amortization.

What amount of leasehold improvements, net of amortization, should Star report in its June 30, 2002, Balance Sheet?

  1. $45,600
  2. $45,000
  3. $44,000
  4. $43,000

$44,000

Six years remained in the lease term at the point the leasehold improvements were made. Thus, they should be amortized over six years, rather than over their eight-year useful life.

Leasehold improvements revert to the lessor at the end of the lease term. As of June 30, 2002, the leasehold improvements have been used only 1/2 year. Thus, the net balance in leasehold improvements is $44,000 [$48,000-($48,000/6)(1/2)].

100

Lind Corp. was a development-stage enterprise from its inception on October 10, 2003 to December 31, 2004. The following were among Lind's expenditures for this period:

  • Leasehold improvements, equipment, and furniture $1,200,000
  • Research and development $850,000
  • Laboratory operations $175,000
  • General and administrative $275,000

The year ended December 31, 2005 was the first year in which Lind was an established operating enterprise. For the period ended December 31, 2004, what total amount of expenditures should Lind have capitalized?

  1. $2,500,000
  2. $2,225,000
  3. $2,050,000
  4. $1,200,000

$1,200,000

Development stage enterprises capitalize the same costs as established on-going enterprises. Thus, only the leasehold improvements, equipment, and furniture ($1,200,000) would have been capitalized. 
Research and development is expensed as incurred, as are most general and administrative costs. There is no information in the question to justify capitalizing the laboratory operations cost.

101

Which one of the following can be measured at fair value at the option of the reporting entity?

  1. A liability under a lease contract.
  2. An investment classified as held-for-trading.
  3. An investment classified as held-to-maturity.
  4. A liability under a pension plan.

An investment classified as held-to-maturity.

An entity may elect to measure and report an investment classified as held-to-maturity at fair value. Traditionally, investments classified as held-to-maturity would be measured and reported at amortized cost, but the provisions of the fair value option permit such investments to be measured and reported at fair value at the option of the reporting entity. - could be either FV or AC

102

On October 1, year 1, Price Corp., a real estate developer, sold land to Greene Co. for $5,000,000. Greene paid $600,000 cash and signed a 10-year $4,400,000 note bearing interest at 12%.  The carrying amount of the land was $4,000,000 on date of sale. The note was payable in forty quarterly principal installments of $110,000 beginning January 2, year 1. Price appropriately accounts for the sale under the cost recovery method.  On January 2, year 2, Greene paid the first principal installment of $110,000 and interest of $132,000.  For the year ended December 31, year 1, what total amount of income should Price recognize from the land sale and financing?

  1. $0
  2. $120,000
  3. $132,000
  4. $252,000

$0

Under the cost recovery method no profit of any type is recognized until the cumulative receipts exceed the cost of the asset sold.  This means that the entire gross profit ($5,000,000 – $4,000,000 = $1,000,000) and the year 1 interest revenue ($132,000) will be deferred until cash collections exceed $4,000,000.  Therefore, no income is recognized in year 1.

103

Which of the following statements concerning the determination of fair value is/are correct?

  • I.The determination of fair value is based on a hypothetical transaction.
  • II.The determination of fair value is based on an exit price.
  • III.The determination of fair value of a nonfinancial asset should be based on the intended use of the asset by the reporting entity.
  1. I only.
  2. II only.
  3. I and II only.
  4. II and III only.

I and II only.

Both Statements I and II are correct. The determination of fair value is based on a hypothetical transaction and on the use of a (hypothetical) exit price. Statement III is not correct. The determination of fair value of a nonfinancial asset should be based on the highest and best use of the asset by market participants, not based on the intended use by the reporting entity.

104

The following computations were made from Clay Co.'s 2005 books:

  • Number of days' sales in inventory 61
  • Number of days' sales in trade accounts receivable 33

What was the number of days in Clay's 2005 operating cycle?

  1. 33
  2. 47
  3. 61
  4. 94

94

The operating cycle is the total period of time from the purchase of inventory, to sale, and then finally to the collection of cash from receivables.

The operating cycle thus can be approximated by the sum of the number of days' sales in inventory, which is the average number of days before an item of inventory is sold, plus the number of days' sales in receivables, which is the average number of days to collect a receivable. This sum is 94 (61 + 33) days.

105

On January 3, year 1, Paterson Services, Inc. signed an agreement authorizing Cobb Company to operate as a franchisee over a 20-year period for an initial franchise fee of $50,000 received when the agreement was signed.  Cobb commenced operations on July 1, year 1, at which date all of the initial services required of Paterson had been performed. The agreement also provides that Cobb must pay a continuing franchise fee equal to 5% of the revenue from the franchise annually to Paterson.  Cobb’s franchise revenue for year 1 was $400,000.  For the year ended December 31, year 1, how much should Paterson record as revenue from franchise fees in respect of the Cobb franchise?

  1. $70,000
  2. $50,000
  3. $45,000
  4. $22,500

$70,000

Initial franchise fees are recognized as revenue when all of the initial services required of the franchisor have been substantially performed.  Continuing franchise fees are reported as revenue as the fees are earned and become receivable. In this case, since all the initial services were performed by 7/1/Y1, the initial fee ($50,000) is recognized as revenue in year 1.  Also, continuing fees of $20,000 (5% × $400,000) should be recognized.  Therefore, the total franchise fee revenue to be recognized in year 1 is $70,000 ($50,000 + $20,000).

106

The IFRS Foundation serves as the administrative umbrella for a group of bodies. Which of the following bodies are NOT included under the IFRS Foundation umbrella?

  1. International Federation of Accountants (IFAC).
  2. International Accounting Standards Board.
  3. IFRS Interpretations Committee.
  4. IFRS Advisory Council.

International Federation of Accountants (IFAC).

The International Federation of Accountants (IFAC) is a global organization for the accounting profession. Its members are accounting and auditing organizations throughout the world. It is an independent organization not under the IFRS Foundation umbrella, but it does support the activities of the IFRS Foundation by encouraging high-quality practices by the world's accountants and auditors.

107

Falton Co. has the following first-year amounts related to its $9mn construction contract:

  • Actual costs incurred and paid $2mn
  • Estimated costs to complete $6mn
  • Progress billings $1.8mn
  • Cash collected $1.5mn

What amount should Falton recognize as a current liability at year end, using the percentage-of-completion method?

  1. $0
  2. $200,000
  3. $250,000
  4. $300,000

$0

The percentage of completion is ($2mn)/($2mn + $6mn) = 25%. This is the ratio of cost incurred to date, divided by the total project cost, which is the sum of cost to date and estimated remaining costs. Gross profit recognized is therefore .25($9mn - $2mn - $6mn) = $250,000. The contract price is $1mn more than the total estimated project cost. At 25% complete, the firm recognizes $250,000 of gross profit. The construction-in-progress balance is therefore $2mn + $250,000 = $2.25mn, the sum of cost to date, plus gross profit to date. With billings only $1.8mn so far, the firm reports a net asset equal to the difference between $2.25mn, the balance in construction in progress, and $1.8mn of billings. Billings are contra to construction in progress for reporting. This $450,000 difference is labeled "cost and profit in excess of billings on long-term contracts" in the balance sheet.

No current liability is reported, because the asset balance (construction in progress) exceeds billings.

108

James Lee, M.D., keeps his accounting records on a cash basis.  During year 2, Dr. Lee collected $100,000 in fees from his patients. At December 31, year 1, Dr. Lee had accounts receivable of $20,000.  At December 31, year 2, Dr. Lee had accounts receivable of $30,000, and unearned fees of $1,000.  On an accrual basis, how much was Dr. Lee’s patient service revenue for year 2?

  1. $111,000
  2. $109,000
  3. $ 90,000
  4. $ 89,000

$109,000

 

109

Which of the following characteristics of accounting information primarily allows users of financial statements to generate predictions about an organization?

  1. Reliability.
  2. Timeliness.
  3. Neutrality.
  4. Relevance.

Relevance.

The question is asking which of the following terms captures predictive value. Predictive value along with confirmatory value is a component of relevance.

  1. Predictive Value
  2. Confirmatory Value
  3. Materiality

110

Which of the following is an appropriate cost approach for determining fair value measurements?

  1. Using relevant information from recent transactions.
  2. Using present value techniques to discount cash flows.
  3. Using the current replacement cost of the asset.
  4. Using the undiscounted cash flows from the asset.

Using the current replacement cost of the asset.

Current replacement cost adjusted for obsolescence can be used for determining fair value measurements under the cost approach.

  1. Relevant information = market approach
  2. discounted cash flows = income approach

111

Acid or Quick Ratio

(Cash + Accounts Receivable + Marketable Securities) / Current Liabiliites

Does NOT include inventory in current assets

Always less than the Current Ratio as inventory is excluded for this ratio.  

112

According to the Private Company Decision-Making Framework, which of the following five items are to be used as a guide to determine if there should be differential guidance between public and private companies.

  1. Historical cost; disclosures; matching; effective date; and transition method.
  2. Recognition and measurement; disclosures; display; balance sheet and income statement; and transition method.
  3. Recognition and measurement; disclosures; display; effective date; and transition method.
  4. Historical cost; disclosures; display; effective date; and transition method.

Recognition and measurement; disclosures; display; effective date; and transition method.

The five items to be used as a guide to determine if there should be differential guidance between public and private companies are:

  • Recognition and measurement—considerations include current guidance relevance, more practical expedients, needs of users, access to management, industry-specific guidance, and cost effectiveness;
  • Disclosures—considerations include current guidance relevance , management access, cost effectiveness, and the need for additional disclosures;
  • Display—considerations include current guidance relevance;
  • Effective date—generally, the effective date is one year after the first annual reporting date for which public companies are required to adopt standards ; and
  • Transition method—considerations include the retrospective method, the modified retrospective method, practical expedients; and cost effectiveness.

113

An increase in the cash-surrender value of a life insurance policy owned by a company would be recorded by:

  1. Decreasing annual insurance expense.
  2. Increasing investment income.
  3. Recording a memorandum entry only.
  4. Decreasing a deferred charge.

Decreasing annual insurance expense.

A portion of the premium is allocated to the cash surrender value, which is an asset to the insured firm. Thus, the insurance expense is reduced by the amount of the premium so allocated.

For example, if the annual premium is $4,000, and the increase in cash surrender value is $800 for the year, insurance expense is $3,200 for the year.

114

On October 31, year 1, a company with a calendar year end paid $90,000 for services that will be performed evenly over a six-month period from November 1, year 1, through April 30, year 2. The company expensed the $90,000 cash payment in October, year 1, to its services expense general ledger account. The company did not record any additional journal entries in year 1 related to the payment. What is the adjusting journal entry that the company should record to properly report the prepayment in its year 1 financial statements?

  1. Debit prepaid services and credit services expense for $30,000.
  2. Debit prepaid services and credit services expense for $60,000.
  3. Debit services expense and credit prepaid services for $30,000.
  4. Debit services expense and credit prepaid services for $60,000.

Debit prepaid services and credit services expense for $60,000.

This question is testing your knowledge of what portion of a cash outlay should be recognized as an asset and what portion should be recognized as an expense. The entire cost of the service is $90,000 for 6 months; therefore, the monthly cost is $15,000 a month. On October 31, the company expensed the entire $90,000, but will receive future benefit over 4 months in the next year. The adjusting entry would be to reduce service expense for $60,000 (4 x $15,000) and increase prepaid services for $60,000.

115

The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage of completion method includes the ratio of

  1. Costs incurred in year three to total billings.
  2. Costs incurred in year three to total estimated costs.
  3. Total costs incurred to date to total billings.
  4. Total costs incurred to date to total estimated costs.

Total costs incurred to date to total estimated costs.

The proportion of completion at the end of any year for a construction contract is the amount of work done, divided by the total amount of work required for the contract. Typically, cost is the measure of "work done." At the end of year three, the numerator is the cost incurred for all three years. The denominator is the total estimated cost of the project, which is the sum of 

  1. the cost incurred for all three years so far, plus 
  2. estimated costs to complete as of the end of year three. 

The percentage of completion changes each year, because both the numerator and denominator change. The gross profit to be reported for year three is the profit for all three years (using the proportion of completion just computed), less the profit already reported in the first two years.

116

During 2005, Rand Co. purchased $960,000 of inventory. The cost of goods sold for 2005 was $900,000, and the ending inventory on December 31, 2005 was $180,000.

What was the inventory turnover for 2005?

  1. 6.4
  2. 6.0
  3. 5.3
  4. 5.0

6.0

Inventory turnover = cost of goods sold/average inventory.

Average inventory is the sum of beginning inventory and ending inventory divided by 2.

To find beginning inventory and average inventory, the basic inventory equation is used:

Beginning inventory + Purchases = Ending inventory + Cost of goods sold

Beginning inventory + $960,000 = $180,000 + $900,000

Beginning inventory = $120,000 

Average inventory = ($180,000 + $120,000)/2 = $150,000

Inventory turnover = cost of goods sold/average inventory

= $900,000/$150,000 = 6

117

Which of the following is an accrued liability?

  1. Cash dividends payable.
  2. Wages payable.
  3. Rent revenue collected 1 month in advance.
  4. Portion of long-term debt payable in current year.

Wages payable.

An accrued liability results from recording an expense that has been incurred but not paid. Wages payable is an example of an expense incurred but not paid.

Accrual —accrual-basis recognition precedes (leads to) cash receipt/expenditure 

  • Revenue—recognition of revenue earned, but not received
  • Expense—recognition of expense incurred, but not paid  

Deferral —cash receipt/expenditure precedes (leads to) accrual-basis recognition

  • Revenue—postponement of recognition of revenue; cash is received, but revenue is not earned
  • Expense—postponement of recognition of expense; cash is paid, but expense is not incurred
  •  

 

118

Savor Co. had $100,000 in cash-basis pretax income for year 2. At December 31, year 2, accounts receivable had in­creased by $10,000 and accounts payable had decreased by $6,000 from their December 31, year 2 balances.  Compared to the accrual basis method of accounting, Savor’s cash pretax income is

  1. Higher by $4,000
  2. Lower by $4,000
  3. Higher by $16,000
  4. Lower by $16,000

Lower by $16,000

This answer is correct. This question requires the calculation of accrual-based income, as shown below.

  • Cash-basis pre-tax income $100,000
  • Increase in accounts receivable + $10,000
  • Decrease in accounts payable + $6,000
  • Accrual-basis income $116,000

This cash pretax income is $16,000 ($116,000 – $100,000) lower than the accrual-basis income.

119

The information provided by financial reporting pertains to

  1. Individual business enterprises, rather than to industries or an economy as a whole or to members of society as consumers.
  2. Individual business enterprises and industries, rather than to an economy as a whole or to members of society as consumers.
  3. Individual business enterprises and an economy as a whole, rather than to industries or to members of society as consumers.
  4. Individual business enterprises, industries, and an economy as a whole, rather than to members of society as consumers.

Individual business enterprises, rather than to industries or an economy as a whole or to members of society as consumers.

SFAC 8 states that information provided by financial reporting pertains to individual business enterprises rather than to industries or an economy as a whole or to members of society as consumers.

120

On January 1, year 1, Peabody Co. purchased an investment for $400,000 that represented 30% of Newman Corp.'s outstanding voting stock. For year 1, Newman reported net income of $60,000 and paid dividends of $20,000. At year end, the fair value of Peabody's investment in Newman was $410,000. Peabody elected the fair value option for this investment. What amount should Peabody recognize in net income for year 1 attributable to the investment?

  1. $6,000
  2. $10,000
  3. $16,000
  4. $18,000

$16,000

Since Peabody has elected to report the investment in Newman using the fair value option, it should recognize its share of cash dividends received during the period (.30 x $20,000 = $6,000) and the increase in the fair value of the investment ($400,000 > $410,000 = $10,000), or $6,000 + $10,000 = $16,000.

121

An entity purchases a trademark and incurs the following costs in connection with the trademark:

  • One-time trademark purchase price $100,000
  • Nonrefundable VAT taxes $5,000
  • Training sales personnel on the use of the new trademark $7,000
  • Research expenditures associated with the purchase of the new trademark $24,000
  • Legal costs incurred to register the trademark $10,500
  • Salaries of the administrative personnel12,000

Applying IFRS and assuming that the trademark meets all the applicable initial asset-recognition criteria, the entity should recognize an asset in the amount of:

  1. $100,000
  2. $115,500
  3. $146,500
  4. $158,500

$115,500

The capitalizable costs for an intangible asset under IFRS 38 are essentially the same as U.S. GAAP. The cost of the asset is the cash paid to acquire the asset, including the cost to obtain legal title and control of the asset. This cost will include the purchase price ($100,000), the taxes ($5,000), and the legal costs to register the asset ($10,500).

The training of the sales personnel ($7,000) or the administrative personnel ($12,000) is not a cost of the asset. The research associated with the purchase of the asset ($24,000) may sound like a cost that can be capitalized-but this cost is for the purchase transaction-not the research of the asset itself. The trademark is already developed when we acquired it-we did not do any research related to the development of the asset.

122

For which one of the following described assets does the guidance for determining fair value as provided in ASC 820, "Fair Value Measurement," not apply?

  1. Accounts receivable.
  2. Investments in debt securities to be held-to-maturity.
  3. Investments in equity securities held for trading.
  4. Inventory reported at lower of cost or market.

Inventory reported at lower of cost or market.

Inventory valuation under lower of cost or market is specifically exempt from the fair value measurement guidance provided by ASC 820, "Fair Value Measurement." The use of lower of cost or market valuation places upper ("ceiling") and lower ("floor") limits on the measurement of "market" that may not result in a true fair value measurement. Thus, the measurement of inventory at "market" is one of the few exceptions to the use of ASC 820 guidance for fair value measurement.

123

Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy?

  1. FIFO (first in, first out).
  2. LIFO (last in, first out).
  3. Moving average.
  4. Weighted average.

FIFO (first in, first out).

Inventory turnover ratio is Cost of Goods Sold/Average Inventory. Therefore, to produce the lowest inventory turnover ratio, we need the highest value of ending inventory. The method that produces the highest value of ending inventory in an inflationary economy (prices are rising) is FIFO.

124

According to the IASB Framework, the financial statement element that is defined as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants, is

  1. Revenue.
  2. Income.
  3. Loss.
  4. Expense.

Expense

  • Asset - An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
  • Liability - A liability is a present obligation of the entity arising from past events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
  • Equity is the residual interest in the assets of the entity after deducting all its liabilities.
  • Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
  • Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

125

According to ASC Topic 820, which of the following is an assumption used in fair value measurements of nonfinancial assets?

  1. The asset is being held for sale.
  2. The asset is in its highest and best use.
  3. The asset must be conservatively valued.
  4. The asset is currently in use.

The asset is in its highest and best use.

Fair value measurement also assumes the highest and best use of the asset. Note that for financial assets and financial liabilities, the highest and best use concept is not relevant since they do not have alternative uses and their fair values do not depend upon their use within a group.  The highest and best use will maximize the value of the asset or group of assets. The use of the asset must be physically possible, legally permissible, and financially feasible at the measurement date.  The highest and best use of the asset is then used to determine the valuation premise used to measure fair value.

126

Identify which of the following is an assumption(s) underlying the preparation and presentation of financial statements under the IASB Framework.

  • Accrual Basis   
  • Going Concern  

BOTH.

There are two assumptions underlying the preparation and presentation of financial statements: accrual basis and going concern. IASB Framework, para 22-23.

US GAAP has 4, and does not specifically reference the accrual method of accounting.  

127

Selected data pertaining to Lore Co. for the calendar year 2005 is as follows:

  • Net cash sales $3,000
  • Cost of goods sold $18,000
  • Inventory at beginning of year $6,000
  • Purchases $24,000
  • Accounts receivable at the beginning of the year $20,000
  • Accounts receivable at the end of the year $22,000

The accounts receivable turnover for 2005 was 5.0 times. What were Lore's 2005 net credit sales?

$105,000

The net cash sales are not involved in the accounts receivable turnover ratio, nor are inventory or purchases. Working backwards from accounts receivable, net credit sales is found as:

Accounts receivable turnover = net credit sales/average accounts receivable.

5 = net credit sales/[($20,000 + $22,000)/2] 
5($21,000) = net credit sales = $105,000

128

Which of the following is a deferred cost that should be amortized over the periods estimated to be benefited?

  1. Prepayment of 3-year insurance premiums on machinery.
  2. Security deposit representing 2-months’ rent on leased office space.
  3. Advance from customer to be returned when sale completed.
  4. Property tax for this year payable next year.

Prepayment of 3-year insurance premiums on machinery.

A deferred cost is a cost which has been paid in advance of its use in the business and is, therefore, an asset which will provide future benefits such as the prepayment of insurance premiums.

129

The FASB’s conceptual framework classifies gains and losses based on whether they are related to an entity’s major ongoing or central operations. These gains or losses may be classified as

  • Nonoperating
  • Operating

BOTH.

Per SFAC 6, gains and losses may be described or classified as "operating" or "nonoperating," depending on their relation to an entity’s major ongoing or central operations.

Gains (losses) are increases (decreases) in equity from peripheral transactions of entity excluding revenues (expenses) and investment by owners (distribution to owners).

Characteristics of gains and losses:

  1. Result from peripheral transactions and circumstances which may be beyond control
  2. May be classified according to sources or as operating and nonoperating
  3. Change in equity reported net

130

Under Statement of Financial Accounting Concepts 8, which of the following does not interact with both relevance and faithful representation to contribute to the usefulness of information?

  1. Comparability.
  2. Timeliness.
  3. Neutrality.
  4. Understandability.

Neutrality.

Neutrality is a component of faithful representation, but does not interact with relevance.

131

According to the IASB Framework for the Preparation and Presentation of Financial Statements, the qualitative characteristic of relevance includes

  1. Timeliness, predictive value, and feedback value.
  2. Comparability and consistency.
  3. Verifiability, neutrality, and representational faithfulness.
  4. Predictive value, confirmatory value, and materiality.

Predictive value, confirmatory value, and materiality.

Relevance.  Information has relevance when it can influence the user’s economic decisions by helping them evaluate past, present, or future events.  Relevance has certain attributes such as predictive value and a confirmatory role.  (Note the change in vocabulary here: in US GAAP, relevance has predictive value and feedback value.)  In addition, IFRS includes materiality under the characteristic of relevance. Relevance is affected by the nature and materiality of the information.  Information is considered material if its omission or misstatement could make a difference in a user’s decision.

132

On December 31, year 1, Reed, Inc. authorized Foy to operate as a franchisee for an initial franchise fee of $75,000.  Of this amount, $30,000 was received upon signing the agreement and the balance, represented by a note, is due in three annual payments of $15,000 each beginning December 31, year 2.  The present value on December 31, year 1, of the three annual payments appropriately discounted is $36,000.  According to the agreement, the nonrefundable down payment represents a fair measure of the services already performed by Reed; however, substantial future services are required of Reed. Collectibility of the note is reasonably certain.  On December 31, year 1, Reed should record unearned franchise fees in respect of the Foy franchise of

  1. $0
  2. $36,000
  3. $45,000
  4. $75,000

$36,000

Franchise fee revenue shall be recognized when all material services have been substantially performed by the franchisor (i.e., the franchisor has no remaining obligation to refund any cash received and substantially all of the initial services of the franchisor have been performed).  Of the initial fee of $75,000, the $30,000 down payment applies to the initial services already performed by Reed.  Additionally, this amount is not refundable.  Therefore, the $30,000 may be recognized as revenue in year 1.  The three remaining $15,000 installments relate to substantial future services to be performed by Reed.  The present value of these payments, $36,000, is recorded as unearned fees and recognized as revenue once substantial performance has occurred.

  • Cash $30,000 
  • Notes Receivable $45,000 
  •       Discount on NR $9,000
  •       Franchise revenue $30,000
  •       Unearned franchise fees $36,000

133

Johan Co. has an intangible asset, which it estimates will have a useful life of 10 years, while Abco Co. has goodwill, which has an indefinite life. Which company should report amortization in its financial statements?

  • Johan
  • Abco  

  • Johan - YES
  • Abco - NO

The intangible asset has a definite life and is amortized. Goodwill has an indefinite life, and is not amortized but is tested for impairment.

134

ear Co., which began operations on January 2, 2005, appropriately uses the installment-sales method of accounting. The following information is available for 2005:

  • Installment sales $1.4mn
  • Realized gross profit on installment sales $240,000
  • Gross profit percentage on sales 40%

For the year ended December 31, 2005, what amounts should Bear report as accounts receivable and deferred gross profit?

  • Accounts receivable
  • Deferred gross profit  

  • Accounts receivable - $800,000
  • Deferred gross profit - $320,000

Under the installment method of accounting, gross profit is recognized in proportion to cash collected on installment sales. Since this is the first year of operations for Bear Co., there is no beginning balance for accounts receivable and no previously deferred gross profit. The year-end balance in accounts receivable is determined by subtracting from total accounts receivable ($1.4mn) the amount collected during the period. Since the gross profit percentage of sales is 40%, the realized gross profit ($240,000) represents 40% of accounts receivable collected. Therefore:

  • .40 X (amount collected) = $240,000
  • X = $240,000/.40
  • X = $600,000 (total A/R collected)

The year-end balance in accounts receivable will be:

  • Sales on account $1,400,000
  • A/R collected ($600,000)
  • A/R balance $800,000

The total deferred gross profit, less the amount realized during the period, will be the year-end deferred gross profit. The total deferred gross profit for the year is 40% of installment sales. Therefore:

  • Installment sales $1,400,000
  • Gross profit rate .40
  • Total deferred gross profit $560,000
  • Less: Amount realized $240,000
  • Year-end deferred gross profit $320,000

135

Alphaco has two subsidiaries, Betaco and Charlieco, both of which are consolidated by Alphaco. Alphaco and Betaco have elected to measure their respective investments held-to-maturity at fair value. Charlieco measures its investments held-to-maturity using amortized cost. In its consolidated financial statements, for which companies, if any, may Alphaco elect to report investment held-to-maturity at fair value?

  1. Alphaco only.
  2. Alphaco and Betaco only.
  3. Alphaco, Betaco, and Charlieco.
  4. None of the companies; all investments held-to-maturity must be measured and reported at amortized cost.

Alphaco, Betaco, and Charlieco.

As the parent, Alphaco may elect to report all of the investments held-to-maturity at fair value in its consolidated statements (only), whether or not the fair value option was elected by its subsidiaries for their separate books and any separate reporting purposes.

136

Gow Constructors, Inc. has consistently used the percentage-of-completion method of recognizing income. In 2004, Gow starts work on an $18mn construction contract that is completed in 2005. 
The following information is taken from Gow's 2004 accounting records:

  • Progress billings $6.6mn
  • Costs incurred $5.4mn
  • Collections $4.2mn
  • Estimated costs to complete $10.8mn

What amount of gross profit should Gow have recognized in 2004 on this contract?

  1. $1.4mn
  2. $1.2mn
  3. $900,000
  4. $600,000

$600,000

Percentage of completion for 2004= $5.4mn/($5.4mn + $10.8mn) = 33%. Gross profit recognized in 2004 = .33[$18mn - ($5.4mn + $10.8mn)] = $600,000.

The denominator of the proportion of completion, which is estimated total project cost, includes cost to date and costs remaining. The proportion is multiplied by total estimated project profit, the difference between contract price and total estimated project cost.

137

Which of the following accounting bases may be used to prepare financial statements in conformity with a comprehensive basis of accounting other than Generally Accepted Accounting Principles?

  • I. Basis of accounting used by an entity to file its income tax return;
  • II. Cash receipts and disbursements basis of accounting.

BOTH.

This question is not asking whether other comprehensive bases of accounting are acceptable under GAAP. Rather, it is simply asking which statements describe a comprehensive basis other than GAAP. Both I and II are found in various situations of accounting practice.

138

On December 31, 2002, Brooks Co. decided to end operations and dispose of its assets within three months. At December 31, 2002, the net realizable value of the equipment was below historical cost.

What is the appropriate measurement basis for equipment included in Brooks' December 31, 2002, Balance Sheet?

  1. Historical cost.
  2. Current reproduction cost
  3. Net realizable value
  4. Current replacement cost

 

Net realizable value

When a firm is in liquidation, historical cost and entry values (replacement cost) are no longer relevant.

The going concern assumption supports the historical cost principle. The firm is no longer a going concern. The only amounts relevant are the amounts to be received on sale of the assets. Net realizable value is the net value to be received, after the costs of getting the asset ready for sale are deducted.

139

Which of the following is not a required component of the 10-K filing?

  1. Product market share.
  2. Description of the business.
  3. Market price of common stock.
  4. Executive compensation.

Product market share.

The market share of the company's product is not a required disclosure. The company may chose to voluntarily present this information, but it is not a required disclosure.

140

Papa Company acquired land with an office building on it from its subsidiary, Sonny Company, for $110,000. Prior to the sale, Sonny's carrying value of the land was $60,000 and its net carrying value of the building was $50,000. At the time of the transaction, Papa appropriately determined that the land had a fair value of $75,000 and the building had a fair value of $35,000.

  1. At what amount should the land and building be reported on Papa's consolidated statements prepared immediately after the transaction?
  2. At what amount should Papa record the land and building on its books at the date of the transaction?

  1. Land = $60,000, Building = $50,000

Even though there was no profit or loss on the intercompany transaction, it resulted in amounts being redistributed between the depreciable asset office building and the non-amortizable asset land, which would result in different amounts of depreciation expense than if the transaction had not occurred. Therefore, the intercompany transaction must be "eliminated" so that the consolidated statements would show land at $60,000 and buildings at $50,000. (Sonny also would need to assess the building for possible impairment.)

  1. Land = $75,000, Building = $35,000

Papa should record the land and building on its books at the appropriately determined fair value at the date of the transaction. The prior carrying values on Sonny's books are not relevant to the amounts at which Papa should record the assets on its books, but are relevant to the amounts that should be reported in the consolidated financial statements.

141

Materiality and relevance are both defined by

  1. What influences or makes a difference to a decision marker.
  2. Quantitative criteria set by the Financial Accounting Standards Board.
  3. The consistency in the application of methods over time.
  4. The perceived benefits to be denied that exceed the perceived costs associated with it.

What influences or makes a difference to a decision marker.

Relevant information is capable of making a difference in a user' s decision. Materiality is entity specific and related to relevance—if omitting it or misstating it could influence a user' s decision. Therefore, materiality and relevance are defined by what influences or makes a difference to a decision maker.

142

According to the cost recovery method of accounting, gross profit on an installment sale is recognized in income

  1. After cash collections equal to the cost of sales have been received.
  2. In proportion to the cash collections.
  3. On the date the final cash collection is received.
  4. On the date of sale.

After cash collections equal to the cost of sales have been received.

This is the most conservative method. Installment methods of recognizing revenue are appropriate only when "collection of the sale price is not reasonably assured." Under the cost recovery method, gross profit is deferred and recognized only when the cumulative receipts exceed the cost of the asset sold.

143

Drew Co. produces expensive equipment for sale on installment contracts.  When there is doubt about eventual collectibility, the income recognition method least likely to overstate income is

  1. At the time the equipment is completed.
  2. The installment method.
  3. The cost recovery method.
  4. At the time of delivery.

The cost recovery method.

Profit is deemed to be realized when a sale in the ordinary course of business is effected, unless the circumstances are such that the collection of the sale price is not reasonably assured. The most conservative accounting treatment in such instances is the cost recovery method, which defers the recognition of any profit until the full cost of the item sold has been collected. Subsequent collections are then considered to be all profit.

144

Which of the following characteristics relates to both accounting relevance and faithful representation?

  1. Free from material error.
  2. Completeness.
  3. Neutrality.
  4. Comparability.

Comparability.

Comparability is the quality of information that enables users to identify similarities and differences between sets of information. For information to be comparable, it must be both relevant (make a difference to a user) and reliable (be accurate and trustworthy).

  1. Comparability
  2. Verifiability
  3. Timeliness
  4. Understandability 

145

For financial statement purposes, the installment method of accounting may be used if the

  1. Collection period extends over more than 12 months.
  2. Installments are due in different years.
  3. Ultimate amount collectible is indeterminate.
  4. Percentage-of-completion method is inappropriate.

Ultimate amount collectible is indeterminate.

The profit on a sale in the ordinary course of business is considered to be realized at the time of the sale unless it is uncertain whether the sales price will be collected. The Board concluded that use of the installment method of accounting is not acceptable unless this uncertainty exists.

146

According to the FASB Conceptual Framework, which of the following correctly pairs a fundamental characteristic of accounting information with one of its components?

  1. Relevance and predictive value.
  2. Relevance and verifiability.
  3. Faithful representation and timeliness.
  4. Faithful representation and confirmatory value.

Relevance and predictive value.

The characteristic of relevance includes the components of predictive value, confirmatory value, and materiality.

147

Before 2001, Droit Co. used the cash basis of accounting. As of December 31, 2001, Droit changed to the accrual basis. Droit cannot determine the beginning balance of supplies inventory.

What is the effect of Droit's inability to determine beginning supplies inventory on its 2001 accrual basis net income and December 31, 2001, accrual basis owners' equity?

  • 2001 net income   
  • 12/31/01 owner's equity  

  • 2001 net income - Overstated
  • 12/31/01 owner's equity - No effect

Supplies expense for 2001 under the accrual method is: supplies expense = beginning supplies + purchases - ending supplies. If beginning supplies cannot be determined, then it is assumed to be zero and supplies expense is understated, causing 2001 income to be overstated. However, total supplies expense for the entire life of the business is unaffected by the inability to determine beginning supplies for 2001. Total supplies expense for the life of the business is total purchases less ending inventory in 2001. These two amounts are determinable, and thus, owners' equity at the end of 2001 can be determined.

From test bank = Inability to determine beginning supplies inventory would cause supplies expense to be understated and year 2 net income to be overstated. Cumulative supplies expense would be properly stated so there would be no effect on December 31, year 2 retained earnings.

148

UVW Broadcast Co. entered into a contract to exchange unsold advertising time for travel and lodging services with Hotel Co. As of June 30, advertising commercials of $10,000 were used. However, travel and lodging services were not provided.

How should UVW account for advertising in its June 30 financial statements?

  1. Revenue and expense are recognized when the agreement is completed.
  2. An asset and revenue for $10,000 is recognized
  3. Both the revenue and expense of $10,000 are recognized.
  4. Not reported.

An asset and revenue for $10,000 is recognized.

UVW has a receivable and revenue for the $10,000 of advertising services provided to date. Without receipt of any travel and lodging services, the firm reports a receivable for the unpaid advertising services. These services will be "paid" in the form of travel and lodging.

149

Working Capital Ratio

Current Assets - Current Liabilities

If positive, there are more CA than CL

150

During year 3, Fleet Co.’s trademark was licensed to Hitch Corp. for royalties of 10% of net sales of the trademarked items. Returns were estimated to be 1% of gross sales.  On signing the licensing agreement, Hitch paid Fleet $75,000 as an advance against future royalty earnings.  Gross sales of the trademarked items during the year were $600,000. What amount should Fleet report as royalty income for year 3?

  1. $54,000
  2. $59,400
  3. $60,000
  4. $75,000

$59,400

Gross sales are $600,000 for Hitch Corp. The estimated 1% returns should be subtracted from gross sales to determine the net sales for the period, or $594,000 ($600,000 – $6,000). Therefore, this answer is correct because the royalty amount for the year is equal to $59,400 ($594,000 net sales × 10% royalty rate).

151

Lane Co., which began operations on January 1, 2005, appropriately uses the installment method of accounting. The following information pertains to Lane's operations for 2005:

  • Installment sales $1,000,000
  • Regular sales $600,000
  • Cost of installment sales $500,000
  • Cost of regular sales $300,000
  • General and administrative expenses $100,000
  • Collections on installment sales $200,000

The deferred gross profit account in Lane's December 31, 2005 balance sheet should be

  1. $150,000
  2. $320,000
  3. $400,000
  4. $500,000

$400,000

Deferred gross profit is the gross profit remaining on uncollected sales accounted for under the installment method. The gross profit percentage is 50% [($1mn - $500,000)/$1mn)] on these sales.


Uncollected installment sales = $800,000 = $1mn - $200,000. Deferred gross profit = $400,000 = .50($800,000)

152

Days Sales in Receivables

365 / AR Turnover = number of days required to collect receivables

153

According to ASC Topic 820, the market that has the greatest volume and level of activity is the

  1. Most advantageous market.
  2. The most relevant market.
  3. The independent market.
  4. The principal market.

The principal market.

ASC Topic 820 defines the principal market as the market with the greatest volume and level of activity.

The fair value measurement assumes that the asset or liability is sold or transferred in either the principal market or the most advantageous market.  The principal marketis a market in which the greatest volume and level of activity occurs.  The most advantageous market maximizes price received for the asset or minimizes the amount paid to transfer the liability.  Market participants in the principal or most advantageous market should have the following characteristics:

  1. Be independent of the reporting entity (not related parties)
  2. Be knowledgeable
  3. Able to transact and,
  4. Willing to transact (i.e. motivated, but not compelled to transact).

This hypothetical price in the principal or most advantageous market should not be adjusted for transaction costs, such as costs to sell.  However, the cost to sell is used to determine which market is the most advantageous.  If location is an attribute of the asset or liability, the price is adjusted for costs necessary to transport the asset or liability to the market.

154

North Co. entered into a franchise agreement with South Co. for an initial fee of $50,000.  North received $10,000 at the agreement’s signing.  The remaining balance was to be paid at a rate of $10,000 per year, beginning the following year. North’s services per the agreement were not complete in the current year.  Operating activities will commence next year. What amount should North report as franchise revenue in the current year?

  1. $0
  2. $10,000
  3. $20,000
  4. $50,000

$0

Revenue can be recognized only when all material services or conditions relating to the sale have been substantially performed by the franchisor. Since North’s services were not complete in the current year, no revenue can be recognized in the current year.

Franchise Agreements 
ASC Topic 952 provides that the initial franchise fee be recognized as revenue by the franchiser only upon substantial performance of their initial service obligation.  The amount and timing of revenue recognized depends upon whether the contract contains bargain purchase agreements, tangible property, and whether the continuing franchise fees are reasonable in relation to future service obligations.  Direct franchise costs are deferred until the related revenue is recognized.

155

If the payment of employees' compensation for future absences is probable, the amount can be reasonably estimated, and the obligation relates to rights that accumulate, the compensation should be

  1. Accrued if attributable to employees' services not already rendered.
  2. Accrued if attributable to employees' services already rendered.
  3. Accrued if attributable to employees' services, whether already rendered or not.
  4. Recognized when paid.

Accrued if attributable to employees' services already rendered.

Only costs that are attributable to employee service already rendered can be accrued. The firm has received no benefit for services that employees have not yet rendered. The firm owes employees nothing for future services and therefore has no liability for these amounts and no cost or expense should be recognized.

156

North Corp. has an employee benefit plan for compensated absences that gives employees ten paid vacation days and ten paid sick days per year.

Both vacation and sick days can be carried over indefinitely. Employees can elect to receive payment in lieu of vacation days; however, no payment is given for sick days not taken.

At December 31, 2004, North's unadjusted balance of liability for compensated absences was $21,000. North estimated that there were 150 vacation days and 75 sick days available at December 31, 2004. North's employees earn an average of $100 per day.

In its December 31, 2004 balance sheet, what amount of liability for compensated absences is North required to report?

  1. $36,000
  2. $22,500
  3. $21,000
  4. $15,000

$15,000

The liability must be accrued only for the vacation pay, because it is probable that paid vacations will be taken. Therefore, the liability is $15,000 (150 days x $100 per day).

The firm may, but is not required to, accrue a liability for sick days. If the employees were routinely paid for sick days not taken, then sick days would be required to be accrued. For this firm, there is no payment for sick days not taken, therefore there is no requirement to accrue this cost.

It may be argued that illness is the condition that mandates payment of sick pay. Illness cannot be predicted and therefore is not required to be accrued.

157

At December 31, 2004, Taos Co. estimates that its employees have earned vacation pay of $100,000. Employees will receive their vacation pay in 2005.

Should Taos accrue a liability at December 31, 2004 if the rights to this compensation accumulated over time or if the rights are vested?

  • Accumulated
  • Vested 

  • Accumulated - YES
  • Vested - YES

Under FAS 43, if compensated absences either accumulate OR vest, then the liability should be accrued. Benefits accumulate if they can be carried over to future years.

For example, assume an employee earns four weeks' vacation per year, but does not take a vacation for two years. If the employee can take an eight-week vacation in the third year, the benefits are said to accumulate (firms usually place restrictions on the total time that can be accumulated).

Benefits vest if they are no longer contingent on continued employment. This means that if an employee retires, he or she will receive their vested vacation pay.

Either way, through accumulation or vesting, it is probable that the vacation compensation will be paid. Therefore, a liability has been incurred as of the balance sheet date.