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Flashcards in FAR 14 Deck (19):
1

On December 1, 20x4, Line Corp. received a donation of 2,000 shares of its $5 par value common stock from a stockholder. On that date, the stock's market value was $35 per share. The stock was originally issued for $25 per share.
By what amount would this donation cause total stockholders' equity to decrease?

A. $70,000
B. $50,000
C. $20,000
D. $0

D. $0

The shares are considered donated treasury shares. Treasury stock and a gain or revenue account are increased by the market value of the stock received in donation (FAS 116). The increase in the treasury stock account decreases the owners' equity, but the gain or revenue increases the owners' equity by the same amount. Therefore, there is no net effect on the owners' equity.

2

Porter Co. began its business last year and issued 10,000 shares of common stock at $3 per share. The par value of the stock was $1 per share.
During January of the current year, Porter bought back 500 shares at $6 per share, which were reported by Porter as treasury stock. The treasury stock shares were reissued later in the current year at $10 per share. Porter used the cost method to account for its equity transactions.

What amount should Porter report as paid-in capital related to its treasury stock transactions on its balance sheet for the current year?

A. $ 1,500
B. $ 2,000
C. $ 4,500
D. $20,000

B. $ 2,000

When treasury stock is reissued at a price exceeding its cost, the cost method records the increase in paid-in capital related to treasury stock. This account is an owners' equity account - treasury stock transactions do not affect earnings. The increase for this situation is 500($10 - $6) = $2,000.
The full entry for re issuance is: dr. Cash $5,000; cr. Treasury stock $3,000; cr. Paid-in capital from treasury stock $2,000

3

The acquisition of treasury stock will cause the number of shares outstanding to decrease if the treasury stock is accounted for by the
Cost method Par value method
Yes No
No No
Yes Yes
No Yes

Yes Yes

The acquisition of treasury stock reduces the number of shares of stock outstanding, regardless of the method used to account for the treasury stock.
Shares in the treasury are considered issued, but not outstanding.

4

In 20x4, Seda Corp. acquired 6,000 shares of its $1 par value common stock at $36 per share. During 20x5, Seda issued 3,000 of these shares at $50 per share. Seda uses the cost method to account for its treasury stock transactions.
What accounts and amounts should Seda credit in 20x5 to record the issuance of the 3,000 shares?

Treasury stock Additional paid-in capital Retained earnings Common stock
$102,000 $42,000 $6,000
$144,000 $6,000
$108,000 $42,000
$108,000 $42,000


Treasury stock Additional paid-in capital

$108,000 $42,000

Under the cost method, when treasury stock is reissued at a price in excess of its cost, additional paid-in capital from treasury stock is credited for the difference. Treasury stock is credited for cost. The journal entry is:

Cash 3,000($50) 150,000
Treasury stock 3,000($36) 108,000
Additional paid-in capital from treasury stock transactions 42,000

5

During the current year, Onal Co. purchased 10,000 shares of its own stock at $7 per share. The stock was originally issued at $6. The firm sold 5,000 of the treasury shares for $10 per share. The firm uses the cost method to account for treasury stock. What amount should Onal report in its income statement for these transactions?

A.
$0

B.
$ 5,000 gain.

C.
$10,000 loss.

D.
$15,000 gain

A.
$0

Income is not affected by treasury stock transactions. When a firm transacts with its owners acting as owners, it cannot profit or report a negative income. In this case, the $3 difference between the $10 reissue price of the treasury stock and its $7 cost is credited to an owners' equity account as paid-in capital from treasury stock transactions. The firm's net worth has increased as a result of its treasury stock purchase and reissuance, but the "gain" is not recognized as earnings.

6

Asp Co. was organized on January 2, 20x5 with 30,000 authorized shares of $10 par common stock. During 20x5, the corporation had the following capital transactions:
January 5 - issued 20,000 shares at $15 per share.
July 14 - Purchased 5,000 shares at $17 per share.
December 27 - Reissued the 5,000 shares held in treasury at $20 per share.
Asp Used the par value method to record the purchase and reissuance of the treasury shares. In its December 31, 20x5 balance sheet, what amount should Asp report as additional paid-in capital in excess of par?

A. $100,000
B. $125,000
C. $140,000
D. $150,000

B. $125,000

Journal entries for the three transactions provide the ending balance in additional paid-in capital.
Under the par method of accounting for treasury stock, the amount of additional paid-in capital FROM ORIGINAL ISSUANCE is reduced when treasury stock is purchased. When treasury stock is reissued, additional paid-in capital is credited for the amount in excess of par, just as in the issuance of unissued shares.

Cash 300,000 20,000(15)
Common Stock 200,000 20,000(10)
Addl paid-in capital 100,000 20,000(15-10)
Treasury stock 50,000 5,000(10)
Addl paid-in capital 25,000 5,000(15-10)
Retained earnings 10,000 5,000(17-15)
Cash 85,000 5,000(17)
Cash 100,000 5,000(20)
Treasury stock 50,000 5,000(10)
Addl paid-in capital 50,000 5,000(20-10)
The ending balance in additional paid-in capital after these transactions is $125,000. Retained earnings was reduced in the second transaction because no additional paid-in capital from treasury stock existed at that point.

7

On December 31, 20x4, Dirk Corp. sold Smith Co. two airplanes and simultaneously leased them back. Additional information pertaining to the sale-leasebacks follows:

Plane #1 Plane #2
Sales price $600,000 $1,000,000
Carrying amount, 12/31/04 $100,000 $550,000
Remaining useful life, 12/31/04 10 years 35 years
Lease term 8 years 3 years
Annual lease payments $100,000 $200,000
In its December 31, 20x4 balance sheet, what amount should Dirk report as deferred gain on these transactions?

A. $950,000
B. $500,000
C. $450,000
D. $0

C. 500,000

Only the $500,000 gain ($600,000 - $100,000) on the sale-leaseback of plane #1 is deferred.
For both capital and operating leases, most gains and losses on the sale in a sale-leaseback are deferred. The gain or loss is an integral part of the transaction and should be recognized over the term of the lease. The exception is when the leaseback part of the transaction is minor. If the present value of the lease payments is 10% or less of the fair value of the property sold, then the leaseback part of the transaction is considered minor and the gain need not be deferred but rather is recognized immediately.

Given that the lease term is less than 10% of the useful life, in all probability the leaseback for plane #2 is a minor one.

8

Able sold its headquarters building at a gain and simultaneously leased back the building. The lease was reported as a capital lease.
At the time of sale, the gain should be reported as

A. Operating income.
B. A gain, net of income tax.
C. A separate component of stockholders' equity.
D. An asset valuation allowance.

D. An asset valuation allowance.

When an asset is sold and then leased back, the lessee defers the gain (subject to certain exceptions, which do not apply in this question). The deferred gain is recorded as a contra account to the leased asset in a capital lease.

9

On June 30, 20x4, Lang Co. sold equipment with an estimated useful life of 11 years and immediately leased it back for 10 years. The equipment's carrying amount was $450,000; the sales price was $430,000; and the present value of the lease payments, which is equal to the fair value of the equipment, was $465,000. In its June 30, 20x4 balance sheet, what amount should Lang report as deferred loss?
A. $35,000
B. $20,000
C. $15,000
D. $0

B. $20,000

The loss on the sale is $20,000 ($450,000 carrying value - $430,000 sales price).


But the fair value of the asset exceeds carrying value.


Thus, the firm has only an "artificial" loss. This loss will most likely be made up by lowering the lease payments on the leaseback. The entire loss is deferred. Whenever the market value exceeds carrying value, a "true" loss has not occurred on the sale and the loss is deferred.

10

A state government condemned Cory Co.'s parcel of real estate. Cory will receive $750,000 for this property, which has a carrying amount of $575,000. Cory incurred the following costs as a result of the condemnation:

Appraisal fees to support a $750,000 value $2,500
Attorney fees for the closing with the state 3,500
Attorney fees to review contract to acquire replacement property 3,000
Title insurance on replacement property 4,000
What amount of cost should Cory use to determine the gain on the condemnation?

A. $581,000
B. $582,000
C. $584,000
D. $588,000

A. $581,000

The total value to be compared to the amount received from the government in computing the gain:

Carrying amount $575,000
Plus appraisal fees to support a $750,000 value 2,500
Plus attorney fees for the closing with the state 3,500
Equals total cost to compare to $750,000 received from state $581,000
The second and third items in the above list essentially reduce the net proceeds from the state and thus decrease the gain. The $3,000 and $4,000 amounts pertaining to the replacement property are not associated with the existing property and do not affect the gain on its condemnation.

11

Gown, Inc. sold a warehouse and used the proceeds to acquire a new warehouse. The excess of the proceeds over the carrying amount of the warehouse sold should be reported as a(an):
A. Extraordinary gain, net of income taxes.
B. Part of continuing operations.
C. Gain from discontinued operations, net of income taxes.
D. Reduction of the cost of the new warehouse.

B. Part of continuing operations.

The excess of proceeds over the carrying value increases the net assets of the firm, is recorded as an ordinary gain, and is included in income from continuing operations. The purchase of the new warehouse is an unrelated transaction.

12

Which of the following conditions must exist in order for an impairment loss to be recognized?
I. The carrying amount of the long-lived asset is less than its fair value.

II. The carrying amount of the long-lived asset is not recoverable.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

B. II only.

The test for impairment for an asset in use is whether the carrying value (book value) is less than its recoverable cost. An asset's recoverable cost is the sum of its estimated net cash inflows projected for its remaining life.
When book value > recoverable cost, the carrying value is not recoverable. In other words, the asset is booked at more than the sum of its future net cash inflows.

For example, if an asset's carrying value is $100 and its recoverable cost is $80, then its carrying value is not recoverable (only $80 is recoverable). The AMOUNT of the loss recognized is the difference between carrying value and fair value, but that difference is not used for TESTING whether an asset is impaired.

That difference is not the condition leading to the impairment loss.

13

On January 1, year one, Newport Corp. purchases a machine for $100,000. The machine is depreciated using the straight-line method over a ten-year period with no residual value. Because of a bookkeeping error, no depreciation was recognized in Newport's year-one financial statements, resulting in a $10,000 overstatement of the book value of the machine on December 31, year one. The oversight was discovered during the preparation of Newport's year-two financial statements. What amount should Newport report for depreciation expense on the machine in the year-two financial statements?

A.
$9,000

B.
$10,000

C.
$11,000

D.
$20,000

B.
$10,000

The year-one error has no bearing on the amount of depreciation to be recognized in subsequent years. Annual depreciation is $10,000 (= $100,000/10). In year two, a Prior period adjustment will be recorded, correcting beginning retained earnings and accumulated depreciation. Year-one statements reported comparatively with year two's statements will be shown correctly. Year two will report $10,000 of depreciation expense.

14

While preparing its 2005 financial statements, Dek Corp. discovers computational errors in its 2004 and 2003 depreciation expense. These errors result in overstatement of each year's income by $25,000, net of income taxes. The following amounts were reported in the previously issued financial statements:

2004 2003
__________ __________
Retained earnings, January 1 $700,000 $500,000
Net income $150,000 $200,000
__________ __________
Retained earnings, December 31 $850,000 $700,000
========== ==========

Dek's 2005 net income is correctly reported at $180,000. Which of the following amounts should be reported as Prior period adjustments and net income in Dek's 2005 and 2004 comparative financial statements?

Year Prior period adjustment Net income
2004 $150,000
2005 ($50,000) $180,000

2004 $150,000
2005 ($50,000) $180,000


2004 ($25,000) $125,000
2005 $180,000


2004 $125,000
2005 - $180,000

Year Prior period adjustment Net income

2004 ($25,000) $125,000
2005 $180,000

15

During 2005, Dale Corp. made the following accounting changes:

Method used in 2004 After-tax Method used in 2005 effect
Sum-of-the-years' digits depreciation Straight-line depreciation $30,000
Weighted-average for inventory valuation First-in, first-out for inventory valuation $98,000
What amounts should be classified in 2005 as Prior period adjustments?

A. $0
B. $30,000
C. $98,000
D. $128,000

A. $0

Neither of the changes listed are Prior period adjustments (PPA). A PPA is an adjustment to the beginning retained earnings balance that corrects the effect on retained earnings of errors in reporting prior-year income. A PPA is not a voluntary accounting change.

The change in inventory method is an accounting principle change, which requires the recording of a cumulative effect of accounting change as an adjustment to retained earnings. This account measures the effect of the change on prior-year net income. The change in depreciation method is treated as an estimate change. The remaining book value at the beginning of the year of change is allocated to the remaining useful life using the new depreciation method.

16

Cuthbert Industrials, Inc. prepares three-year comparative financial statements. In year 3, Cuthbert discovered an error in the previously issued financial statements for year 1. The error affects the financial statements that were issued in years 1 and 2. How should the company report the error?
A. The financial statements for years 1 and 2 should be restated; an offsetting adjustment to the cumulative effect of the error should be made to the comprehensive income in the year 3 financial statements.
B. The financial statements for years 1 and 2 should not be restated; financial statements for year 3 should disclose the fact that the error was made in prior years.
C. The financial statements for years 1 and 2 should not be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.
D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.

D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.


When there is an error in prior period financial statements and those statements are presented with the current year, the error should be corrected in years 1 and 2 so they are comparative to year 3. The effect of the error should be reflected in the year 3 beginning balances of the appropriate asset and liabilities.

17

In single period statements, which of the following should be reflected as an adjustment to the opening balance of retained earnings?
A. Effect of a failure to provide for uncollectible accounts in the previous period.
B. Effect of a decrease in the estimated useful life of depreciable equipment.
C. Adoption of a new accounting method for transactions that in the past had an immaterial effect on the financial statements.
D. Cumulative effect of a change from an accelerated method to straight-line depreciation.

A. Effect of a failure to provide for uncollectible accounts in the previous period.

This is an error correction. The correction of an error affecting the income of prior periods is accounted for as a Prior period adjustment. This adjustment corrects the beginning retained earnings balance in the period the error was discovered, thereby correcting the retained earnings carried forward from earlier periods.

18

Conn Co. reports a retained-earnings balance of $400,000 at December 31, 2004.
In August 2005, Conn determines that insurance premiums of $60,000 for the three-year period beginning January 1, 2004 had been paid and fully expensed in 2004. Conn has a 30% income tax rate.

What amount should Conn report as adjusted beginning retained earnings in its 2005 statement of retained earnings?

A. $420,000
B. $428,000
C. $440,000
D. $442,000


B. $428,000

The 2005 statement of retained earnings must disclose a Prior period adjustment to the beginning retained-earnings balance for the amount required to correct prior-year net income.
2004 insurance expense actually recognized (in error) $60,000
Less 2004 correct insurance expense - the amount that should have been recognized ($60,000/3 - a three-year policy) (20,000)
Equals the error in pre-tax income before 2005(income understated) $40,000
Times (1 - tax rate) to determine after-tax error x .70
Equals the error correction, the amount by which retained earnings at January 1, 2005 must be increased(the Prior period adjustment) $28,000
Plus unadjusted retained earnings at January 1, 2005 $400,000
Equals adjusted retained earnings at January 1, 2005 $428,00

19

In which of the following situations should a company report a Prior period adjustment?
A. A change in the estimated useful lives of fixed assets purchased in prior years.
B. The correction of a mathematical error in the calculation of prior years' depreciation.
C. A switch from the straight-line to double-declining-balance method of depreciation.
D. The scrapping of an asset prior to the end of its expected useful life.


B. The correction of a mathematical error in the calculation of prior years' depreciation.

A Prior period adjustment is defined as the correction of an error affecting prior-year income. The adjustment reverses the error by correcting beginning retained earnings in the year of discovery. If depreciation in a prior year is misstated, then income in that year is also incorrect, as well as the balance in retained earnings. The Prior period adjustment corrects retained earnings and accumulated depreciation.