Basic Concepts & Financial Statements Flashcards
On September 25, 2014 Colson Corp. sold 200,000 widgetrons to Cavanaugh Corp at $5 per unit. Half of the units were delivered on November 15, 2014, and the remaining 100,000 units were delivered on January 20, 2015. At the time of sale Cavanaugh paid 40% of the contract price and agreed to pay the rest in equal installments on the two delivery dates. What amount of revenue should Colson recognize from this sale in 2014? A. $0 [1%] B. $500,000 [57%] C. $700,000 [16%] D. $1,000,000 [23%]
Choice B (Correct) and Choice C (Incorrect): Revenue is recognized when the earnings process is substantially complete and when the revenue is either realized or realizable. The earnings process is complete in regard to the first 100,000 units that were delivered in 2014. In addition, a portion of the money has been received and the remainder is receivable. Unless Colson has no basis for determining if the remainder of the sales price is collectible, the sales price is partially realized with the remainder realizable. As a result, Colson would recognize revenues on the 100,000 units delivered at $5 per unit for a total of $500,000. While $700,000 of the payments have been received, the earning process is substantially complete with regard to only half the order, so only half the revenue of the order is recognized.
How are dividends per share for common stock used in the calculation of the following?
payout ratio
Dividend per share Earnings per share
A. Numerator Numerator [14%]
B. Numerator Not used [57%]
C. Denominator Not used [19%]
D. Denominator Denominator [8%]
Choice B (Correct): The dividend per share payout ratio is the ratio of dividends per share to earnings per share, making dividends per share the numerator. Earnings per share, on the other hand, is net income attributable to common stockholders divided by weighted average shares. Dividends have no effect.
On April 1, Year 3, Ivy began operating a service proprietorship with an initial cash investment of $1,000. The proprietorship provided $3,200 of services in April and received full payment in May. The proprietorship incurred expenses of $1,500 in April, which were paid in June. During May, Ivy drew $500 against her capital account. What was the proprietorship’s income for the two months ended May 31, Year 3, under the following methods of accounting?
Cash basis Accrual basis
A. $1,200 $1,200 [3%]
B. $1,700 $1,700 [11%]
C.$2,700 $1,200 [25%]
D.$3,200 $1,700 [58%]
Cash basis accounting (cash method) recognizes revenue when cash is received and expense when cash is paid. By contrast, accrual basis accounting recognizes revenue when earned and expense when incurred, regardless of when cash is exchanged. GAAP requires accrual basis for external reporting, but companies sometimes use cash basis for internal purposes.
Transactions for the two months ended May 31 are accounted for as follows:
Regardless of the accounting method, the $1,000 initial investment and $500 capital draw affect only the balance sheet, not the income statement.
Under cash basis, the only income item recognized is $3,200 in revenue because that is the only time cash was exchanged in the period. Because the $1,500 expense was not paid during the period, it is not included under cash basis.
Under accrual basis, both the revenue and the expense are recognized because they were earned/incurred in the period.
Cash basis Accrual basis
Revenue: $3,200 received in May $3,200 earned in April
Expenses: Paid after May 31 (not included) $1,500 incurred in April
Net income: $3,200 $1,700
(Choices A, B, and C) The capital draw is not an expense. In addition, expenses paid after May 31 are not included in cash basis income because they were not paid in the period.
Things to remember:
Cash basis accounting recognizes revenue when cash is received and expense when cash is paid. Accrual basis accounting recognizes revenue when earned and expense when incurred. GAAP requires accrual basis accounting for external reporting.
Rice Co. was incorporated on January 1, 20X1, with $500,000 from the issuance of stock and borrowed funds of $75,000. During the first year of operations, net income was $25,000. On December 15, Rice paid a $2,000 cash dividend. No additional activities affected owners’ equity in 20X1. At December 31, 20X1, Rice’s liabilities had increased to $94,000. In Rice’s December 31, 20X1, balance sheet, total assets should be reported at
A. $598,000 [24%]
B. $600,000 [5%]
C. $617,000 [49%]
D. $692,000 [20%]
Choice C (Correct): With an initial equity of $500,000, income of $25,000 and dividends of $2,000, Rice would have total stockholders’ equity of $523,000 at 12/31/X1. With liabilities of $94,000, assets will equal the total of liabilities and stockholders’ equity or $617,000.
Palmyra Co. has net income of $11,000, a positive $1,000 net cumulative effect of a change in accounting principle, a $3,000 unrealized loss on available-for-sale securities, a positive $2,000 foreign currency translation adjustment, and a $6,000 increase in its common stock. What amount is Palmyra’s comprehensive income?
A. $4,000 [6%]
B. $10,000 [35%]
C. $11,000 [34%]
D. $17,000 [23%]
Comprehensive income measures economic performance by calculating an entity’s change in equity from nonowner transactions and events. Comprehensive income includes revenues, expenses, gains, and losses related to net income and to other comprehensive income (OCI).
Palmyra’s comprehensive income of $10,000 is calculated as follows:
Net income 11,000 - OCI (3,000 unreallized loss on AFS) + (2,000 Foreign currency translation) = 10,000
Things to remember: Comprehensive income (net income and other comprehensive income) includes changes in equity from nonowner transactions and events. Transactions that affect equity but not current earnings (eg, owner transactions and the cumulative effect of a change in accounting principle) are not components of comprehensive income.
At December 30, 20X0, Solomon Co. had a current ratio greater than 1:1 and a quick ratio less than 1:1. On December 31, 20X0, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?
A. Decreased current ratio and increased quick ratio. [13%]
B. Decreased current ratio and decreased quick ratio. [34%]
C. Increased current ratio and decreased quick ratio. [38%]
D. Increased current ratio and increased quick ratio. [13%]
Choice C (Correct) and Choices A, B, D (Incorrect): If the current ratio is greater than 1:1 and the quick ratio is less than 1:1, it means that the total of quick assets (cash and receivables) is less than current liabilities; but that all current assets (quick assets plus inventory) is greater than current liabilities. A payment of accounts payable will increase the current ratio since it was greater than 1:1 and decrease the quick ratio since it was lower than 1:1.
Sleeth Co. has an investment in shares of a public company that are temporarily restricted and may not be transferred or sold for a period of 18 months. Unrestricted shares of the public company are actively traded on the New York Stock Exchange, and most analysts agree that the restriction would cause investors to discount the stock by 10%. The investment does not give Sleeth Co. control of the company or the ability to exercise significant influence over it. If Sleeth Co. reports this investment at fair value, which level of inputs will it use in the valuation?
A. Level 1. (39%)
B. Level 2. (41%)
C. Level 3. (8%)
D. This investment must be accounted for under the equity method and may not be reported at fair value. (10%)
The fair value hierarchy provides guidance on measuring financial assets and liabilities. The hierarchy has three levels of inputs that are ordered from highest to lowest in preference and reliability. Level 2 inputs are based on observable transactions from active or inactive markets for similar assets or liabilities.
Sleeth is utilizing trading information from the New York Stock Exchange (NYSE) to value its shares of the public company. However, Sleeth’s investment may not be transferred or sold for 18 months, while the NYSE shares have no such restriction (ie, comparing similar assets). Since Sleeth is valuing its shares using observable market information that is similar to its investment, the company will disclose a Level 2 input in its footnotes.
(Choice A) While Level 1 assets are also based on quoted prices in active markets, Level 1 applies to identical assets. A valuation using a similar asset in an active market is considered a Level 2 input.
(Choice C) Level 3 inputs are unobservable and reflect an entity’s assumptions about market participants. Sleeth is utilizing actual NYSE data and is not making assumptions about the asset’s current trading value.
(Choice D) The equity method is used when an investor can significantly influence an investment. Since Sleeth can neither control nor significantly influence its investment, the fair value method is more appropriate in this situation.
Things to remember:
The fair value hierarchy establishes the order of inputs applied (starting with the most objective and reliable) to measure certain financial assets and liabilities. The first two levels are based on observable inputs; Level 1 inputs are quoted prices of identical assets in active markets and Level 2 inputs come from similar assets in active or inactive markets.
A company’s activities for Year 2 included the following:
Gross sales $3,600,000
Cost of goods sold $1,200,000
Selling and administrative expense $500,000
Adjustment for prior-year understatement of amortization expense $59,000
Sales returns $34,000
Gain on sale of available-for-sale debt securities $8,000
Gain on disposal of a discontinued business segment $4,000
Unrealized holding gain (noncredit related) on available-for-sale debt securities $2,000
The company has a 30% effective income tax rate. What is the company’s net income for Year 2?
A. $1,267,700 (16%)
B. $1,273,300 (37%)
C. $1,314,600 (35%)
D. $1,316,000 (11%)
Choice C (Correct) and Choices A, B, D (Incorrect): The company’s net income for Year 2 is $1,314,600. Net income is calculated as follows:
Gross sales $3,600,000
Cost of goods sold (1,200,000)
Selling and administrative expense (500,000)
Sales returns (34,000)
Operating Income = 1,866,000
Non-operating Income 8,000
Provision for income taxes (562,200)
$1,874,000 × 30%
Income from continuing operations = 1,311,800
Discontinued operations, net of tax 2,800
$4,000 ×(1 − 30%)
Extraordinary items 0
Net Income = $1,314,600
