FAR 2 Flashcards
(26 cards)
Miller Co. incurred the following computer software costs for the development and sale of software programs during the current year:
Planning costs $ 50,000
Design of the software 150,000
Substantial testing of the project’s initial stages 75,000
Production and packaging costs for the first
month’s sales 500,000
Costs of producing product masters after
technology feasibility was established 200,000
The project was not under any contractual arrangement when these expenditures were incurred. What amount should Miller report as research and development expense for the current year?
A.
$200,000
Correct B.
$275,000
C.
$500,000
D.
$975,000
FASB ASC 730-10-20 defines research and development as the planned search and critical investigation aimed at the discovery of new knowledge and ultimately a new product. Computer software costs follow this definition. Computer software costs to be sold, leased, or otherwise marketed are charged to expense as research and development until technological feasibility has been established for the product. After feasibility has been established, all software costs are capitalized. Based on the definition, research and development expense includes planning, design and testing of $275,000 ($50,000 + 150,000 + 75,000).
Some events provide evidence regarding conditions that did not exist on the balance sheet date, but arose subsequently and do not require an adjustment of the balance sheet. Assuming that the item is material, an example of a subsequent event that requires adjustment is:
A.
sale of bonds.
Incorrect B.
loss from inventory fire.
C.
stock splits.
D.
loss on account receivable resulting from customer’s bankruptcy.
The loss on account receivable resulting from a customer’s bankruptcy relates to an account that existed on the balance sheet date and an adjustment is needed.
FASB ASC 855-10 provides guidance as to subsequent events that require recognition:
Quote
An entity shall recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.
FASB ASC 855-10-25-1
Quote
The following are examples of recognized subsequent events:
a. If the events that gave rise to litigation had taken place before the balance sheet date and that litigation is settled, after the balance sheet date but before the financial statements are issued or are available to be issued, for an amount different from the liability recorded in the accounts, then the settlement amount should be considered in estimating the amount of liability recognized in the financial statements at the balance sheet date.
b. Subsequent events affecting the realization of assets, such as receivables and inventories or the settlement of estimated liabilities, should be recognized in the financial statements when those events represent the culmination of conditions that existed over a relatively long period of time. For example, a loss on an uncollectible trade account receivable as a result of a customer’s deteriorating financial condition leading to bankruptcy after the balance sheet date but before the financial statements are issued or are available to be issued ordinarily will be indicative of conditions existing at the balance sheet date. Thus, the effects of the customer’s bankruptcy filing shall be considered in determining the amount of uncollectible trade accounts receivable recognized in the financial statements at the balance sheet date.
FASB ASC 855-10-55-1
Roro, Inc., paid $7,200 to renew its only insurance policy for three years on March 1, 20X1, the effective date of the policy. On March 31, 20X1, Roro’s unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Roro’s financial statements for the 3 months ending March 31, 20X1?
A.
Prepaid insurance: $7,000; Insurance expense: $300
Correct B.
Prepaid insurance: $7,000; Insurance expense: $500
C.
Prepaid insurance: $7,200; Insurance expense: $300
D.
Prepaid insurance: $7,300; Insurance expense: $200
This question indicates that on Roro’s unadjusted trial balance the full 3-year premium of $7,200 for the renewal of the policy has been expensed. The prepaid insurance account still contains $300 of unamortized premiums from the old policy. The accountant must make adjusting entries to achieve the following:
•Expense the remaining premium of the old policy.
•Transfer the premium for the new policy to the prepaid insurance account.
•Amortize one month of expense on the new policy.
Calculation of account balances:
Monthly amortization = Policy cost / 36 months
= $7,200 / 36
= $200 / month
Prepaid insurance Policy 1 month
balance on 3/31/X1 = cost - amortization
= $7,200 - $200
= $7,000
======
Insurance expense on 3/31/X1:
Amortization of prior policy $300
March amortization of renewal 200
----
Total expense on 3/31/X1 $500
====
Neron Co. has two derivatives related to two different financial instruments, Instrument A and Instrument B, both of which are debt instruments. The derivative related to Instrument A is a fair value hedge, and the derivative related to Instrument B is a cash flow hedge. Neron experienced gains in the value of Instruments A and B due to a change in interest rates. Which of the gains should be reported by Neron in its income statement?
A.
Gain in value of both debt Instruments A and B
B.
Gain in value of debt Instrument A only
C.
Gain in value of debt Instrument B only
D.
Neither gain in value of debt Instrument A or B
FASB ASC 815-25-35-1 requires that gains or losses associated with changes in the fair value of the hedging instrument be recognized in net income in the period in which the change in fair value takes place.
The gain or loss resulting from changes in the fair value of a cash flow hedge is included in other comprehensive income.
Consequently, only the gain in the value of Instrument A would be included in net income.
Posy Corp. acquired treasury shares at an amount greater than their par value, but less than their original issue price. Compared to the cost method of accounting for treasury stock, the par value method reports a greater amount for:
Incorrect A.
additional paid-in capital.
B.
retained earnings.
C.
both additional paid-in capital and retained earnings.
D.
neither additional paid-in capital nor retained earnings.
Assume:
Par value of shares = $1,000
Original issue price = $1,200 ($1,000 par, $200 additional
paid-in capital)
Reacquisition price = $1,100
(1) Reacquisition using cost method:
Dr. Cr. Treasury shares $1,100
Cash $1,100 (2) Reacquisition using par value method:
Dr. Cr. Treasury shares $1,000 Additional paid-in capital 100 Cash $1,100 The entry under the par value method reduces additional paid-in capital (i.e., the amount is not “greater”), while retained earnings are not affected.
Note
The question asks if the amount is “greater,” not just if the account is affected.
Theoretically, which of the following costs incurred in connection with a machine purchased for use in a company’s manufacturing operations would be capitalized?
A.
Insurance on the machine while in transit
B.
Testing and preparation of the machine for use
C.
Both insurance on the machine while in transit and testing and preparation of the machine for use
Incorrect D.
Neither insurance on the machine while in transit nor testing and preparation of the machine for use
The capitalized cost of a machine would include all costs of acquiring, transporting, installing, and testing of the machine for its intended use, up to the time the machine was placed in use.
This total acquisition cost would, therefore, include insurance during transit and testing and preparation of the machine for use.
Insurance and operating costs incurred subsequent to placing the machine in operation would be treated as product or period costs.
On November 1, 20X1, Key Co. paid $3,600 to renew its only insurance policy for three years. On December 31, 20X1, Key’s unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Key’s December 31, 20X1, financial statements?
A.
Prepaid insurance: $3,300; Insurance expense: $1,200
B.
Prepaid insurance: $3,400; Insurance expense: $1,200
C.
Prepaid insurance: $3,400; Insurance expense: $1,100
D.
Prepaid insurance: $3,490; Insurance expense: $1,010
id insurance on November 1, 20X1 $3,600
Less November and December expense
2($3,600/36 months) 200
——
Prepaid insurance on December 31, 20X1 $3,400
======
Insurance expense Total payments Prepaid insurance
on December 31, 20X1 = for insurance - balance
= ($90 + $4,410) - $3,400
= $4,500 - $3,400
= $1,100
Note
Because the trial balance does not show a prepaid amount for the $3,600, and the $90 amount is too small to relate reasonably to the renewal policy, it can be assumed that the books need to be adjusted to transfer the correct prepaid amount ($3,400) from expense and expense the $90, which likely represents the expired remainder of the old policy.
Davis Tire Co. has a deferred compensation plan for several key employees. Each employee’s plan contains an agreement not to compete and has a different set of benefits. How should Davis Co. account for this plan?
A.
The plan should be accounted for as a pension plan or as a health and welfare plan.
B.
The plan should be accounted for as a current expense and accrued liability each year of an employee’s service life.
C.
Deferred compensation plans do not need to be reported or disclosed.
D.
A liability, not less than the sum of the nondiscounted future cash flows, should be reported.
A deferred compensation plan which is not the equivalent of a pension plan should be reported in accordance with FASB ASC 710-10-25-11. Davis Co. would accrue a liability of not less than the present value of the estimated future payments
r interim financial reporting, a company’s income tax provision for the second quarter of 20X1 should be determined using the:
A.
effective tax rate expected to be applicable for the full year of 20X1 as estimated at the end of the first quarter of 20X1.
Correct B.
effective tax rate expected to be applicable for the full year of 20X1 as estimated at the end of the second quarter of 20X1.
C.
effective tax rate expected to be applicable for the second quarter of 20X1.
D.
statutory tax rate for 20X1.
For interim financial reporting:
•at the end of each interim period an estimate should be made of the expected tax rate applicable to the full fiscal year and
•this rate should be used to develop the income tax provision for the affected interim period.
Specifically, the income tax provision for the second quarter of 20X1 would be calculated using the full-year estimated tax rate for 20X1 estimated at the end of the second quarter.
FASB ASC 740-270-35-2 and 35-3
Ace Corp. entered into a troubled debt restructuring agreement with National Bank. National agreed to accept land with a carrying amount of $75,000 and a fair value of $100,000 in payment and cancellation of a note (from Ace) with a carrying amount of $150,000. Disregarding income taxes, what amount should Ace report as a gain in its income statement?
Incorrect A.
$0
B.
$25,000
C.
$50,000
D.
$75,000
n computing gain or loss, assets conveyed in a troubled debt restructuring should be valued at their fair value. Therefore:
Carrying amount of note $150,000
Less fair value of land 100,000
——-
Gain $ 50,000
=======
Lime Co.’s payroll for the month ending January 31, 20X1, is summarized as follows:
Total wages $10,000
Federal income tax withheld 1,200
All wages paid were subject to the Federal Insurance Contributions Act (FICA). FICA tax rates were 7.65% each for employee and employer. Lime remits payroll taxes on the 15th of the following month. In its financial statements for the month ending January 31, 20X1, what amounts should Lime report as total payroll tax liability and as payroll tax expense?
A.
Liability: $1,200; Expense: $1,530
Incorrect B.
Liability: $1,965; Expense: $1,530
C.
Liability: $1,965; Expense: $765
D.
Liability: $2,730; Expense: $765
Payroll tax liability:
Federal income tax withheld $1,200
Employee FICA (7.65% x $10,000) 765
Employer FICA (7.65% x $10,000) 765
------
Total $2,730
Payroll tax expense:
•Employer FICA (7.65% × $10,000) = $765
Which of the following is an eligible item for the fair value measurement option under FASB ASC 825-10-15-4?
A.
An investment in a subsidiary that the entity is required to consolidate
B.
The rights and obligations under an insurance contract that is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a cash settlement) but whose terms permit the insurer to settle by paying a third party to provide those goods or services
C.
Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits or other postretirement benefits
Incorrect D.
None of the answer choices are eligible items.
FASB ASC 825-10-15-4 lists the following items that are eligible for the fair value election:
Quote
a. A recognized financial asset and financial liability, except any listed in the following paragraph
b. A firm commitment that would otherwise not be recognized at inception and that involves only financial instruments (An example is a forward purchase contract for a loan that is not readily convertible to cash. That commitment involves only financial instruments—a loan and cash—and would not otherwise be recognized because it is not a derivative instrument.)
c. A written loan commitment
d. The rights and obligations under an insurance contract that is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a cash settlement) but whose terms permit the insurer to settle by paying a third party to provide those goods or services
e. The rights and obligations under a warranty that is not a financial instrument (because it requires or permits the warrantor to provide goods or services rather than a cash settlement) but whose terms permit the warrantor to settle by paying a third party to provide those goods or services
f. A host financial instrument resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument under [FASB ASC] 815-15-25-1, subject to the scope exceptions in paragraph 8. (An example of such a nonfinancial hybrid instrument is an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash.)
Beach Co. determined that the decline in the fair market value (FMV) of an investment was below the amortized cost and permanent in nature. The investment was classified as available-for-sale on Beach’s books. The controller would properly record the decrease in FMV by including it in which of the following?
A.
Other comprehensive income section of the income statement only
Correct B.
Earnings section of the income statement and writing down the cost basis to FMV
C.
Extraordinary items section of the income statement, net of tax, and writing down the cost basis to FMV
D.
Other comprehensive income section of the income statement and writing down the cost basis to FMV
Available-for-sale securities are recognized on the balance sheet at fair value. Any related unrealized holding gains and losses are excluded from net income and reported as other comprehensive income. However, if a decline in value is not temporary, the cost basis of the individual security should be written down to fair value and the amount of the write-down is included in earnings.
company has a long-lived asset with a carrying value of $120,000, expected future cash flows of $130,000, present value of expected future cash flows of $100,000, and a market value of $105,000. What amount of impairment loss should be reported?
Correct A.
$0
B.
$5,000
C.
$15,000
D.
$20,000
If the sum of the estimated future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity may have to recognize an impairment loss. The impairment loss, if any, to be recognized is any excess of the asset’s carrying amount over its fair value. Notice, however, that no impairment loss is to be recognized unless the asset’s estimated future cash flows (ECF) are less than its carrying amount, even if the asset’s carrying amount (CA) exceeds its fair value (FV).
Since the estimated future cash flows ($130,000) are not less than the carrying value ($120,000), no impairment loss must be recognized.
Jen Co. had 200,000 shares of common stock and 20,000 shares of 10%, $100 par value cumulative preferred stock. No dividends on common stock were declared during the year. Net income was $2,000,000. What was Jen’s basic earnings per share?
A.
$9.00
B.
$9.09
C.
$10.00
Incorrect D.
$11.11
Basic earnings per share is (Net income - Preferred stock dividends) ÷ Weighted-average common shares.
•$2,000,000 - (20,000 × $100 × 0.10) ÷ 200,000 = $9.00
An extraordinary gain should be reported as a direct increase to which of the following?
A.
Net income
Incorrect B.
Comprehensive income
C.
Income from continuing operations, net of tax
D.
Income from discontinued operations, net of tax
Extraordinary items are presented immediately below the discontinued operations section of the income statement. Descriptive captions are used, and the extraordinary items are presented net of the related tax effect.
For a capital lease, the amount recorded initially by the lessee as a liability should normally:
A.
exceed the total of the minimum lease payments.
B.
exceed the present value of the minimum lease payments at the beginning of the lease.
C.
equal the total of the minimum lease payments.
Correct D.
equal the present value of the minimum lease payments at the beginning of the lease.
FASB ASC 840-30-30-1, in a discussion of accounting and reporting by lessees, notes that:
Quote
The lessee shall measure a capital lease asset and capital lease obligation initially at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term.
In Year 2, Ajax, Inc., reported taxable income of $400,000 and pretax financial statement income of $300,000. The difference resulted from $60,000 of nondeductible premiums on Ajax’s officers’ life insurance and $40,000 of rental income received in advance. Rental income is taxable when received. Ajax’s effective tax rate is 30%. In its Year 2 income statement, what amount should Ajax report as income tax expense—current portion?
A.
$90,000
Incorrect B.
$102,000
C.
$108,000
D.
$120,000
Income tax expense—current is the tax currently payable ($400,000 × 0.30 = $120,000).
Journal Entry:
Tax expense-current 120,000
Tax payable 120,000
On November 2, 20X1, Platt Co. entered into a 90-day futures contract to purchase 50,000 Swiss francs when the contract quote was $0.70. The purchase was for speculation in price movement. The following exchange rates existed during the contract period:
30-Day Futures Spot Rate
-------------- --------- November 2, 20X1 $.62 $.63 December 31, 20X1 .65 .64 January 30, 20X2 .65 .68 What amount should Platt report as foreign currency exchange loss in its income statement for the year ended December 31, 20X1?
A.
$2,500
Incorrect B.
$3,000
C.
$3,500
D.
$4,000
Futures contracts are a selected type of derivative instrument. All derivatives must be recognized on the balance sheet at fair value. Fair value is $0.70 on November 2, 20X1. Accounting for the changes in fair value depends on whether it has been designated as and qualifies for hedge accounting. Platt Co. has not hedged the risk of the futures contract and FASB ASC 815-20-35-1 specifies that gains and losses must be included in income for these contracts. Since this is a futures contract, the future 30-day rate ($0.65) is used to measure the gain or loss for the year ended December 31, 20X1. The foreign currency exchange loss for 20X1 is ($.70 - $.65) × 50,000 = $2,500.
In 20X1, a personal injury lawsuit was brought against Halsey Co. Based on counsel’s estimate, Halsey reported a $50,000 liability in its December 31, 20X1, balance sheet. In November 20X2, Halsey received a favorable judgment, requiring the plaintiff to reimburse Halsey for expenses of $30,000. The plaintiff has appealed the decision, and Halsey’s counsel is unable to predict the outcome of the appeal. In its December 31, 20X2, balance sheet, Halsey should report what amounts of asset and liability related to these legal actions?
A.
Asset: $30,000; Liability: $50,000
Incorrect B.
Asset: $30,000; Liability: $0
C.
Asset: $0; Liability: $20,000
D.
Asset: $0; Liability: $0
FASB ASC 450-20-25-2 provides for:
•accrual of a loss if such loss is probable and can be reasonably estimated, and
•no accrual of gains.
FASB ASC 450-20-55-12 indicates:
Quote
If the underlying cause of the litigation, claim, or assessment is an event occurring before the date of an enterprise’s financial statements, the probability of an outcome unfavorable to the enterprise must be assessed to determine whether the condition in paragraph 8(a) is met. Among the factors that should be considered are the nature of the litigation, claim, or assessment, the progress of the case (including progress after the date of the financial statements but before those statements are issued or are available to be issued, with the appropriate date determined in accordance with Statement 165), the opinions or views of legal counsel and other advisers, the experience of the enterprise in similar cases, the experience of other enterprises, and any decision of the enterprise’s management as to how the enterprise intends to respond to the lawsuit, claim, or assessment (for example, a decision to contest the case vigorously or a decision to seek an out-of-court settlement).
Since the outcome of the appeal cannot be predicted, no asset (gain) should be reported. Since Halsey received a favorable judgment, the liability accrued in 20X1 is no longer appropriate. (And the legal costs have probably already been expensed.) However, the lawsuit and appeal should be disclosed in a footnote.
A. A. Corporation has a loading dock that is situated next to a local highway. Recently, a new major highway was completed nearby, which bypasses the loading dock, and has thus made the installation of questionable future value to the corporation. The carrying amount of the loading dock is $400,000. The undiscounted present value of the future cash flows related to the loading dock is $410,000. The discounted present value of the future cash flows related to the loading dock is $380,000. The loading dock could be sold for $401,000 right now, less a broker’s commission of $6,000. If A. A. Corporation applies IFRS, does it need to recognize an impairment loss?
A.
No, since the undiscounted cash flows are larger than the carrying value
B.
Yes, because the carrying value is not recoverable
C.
No, because the dock can be sold for its carrying value
Incorrect D.
Yes, because the discounted present value of the cash flows from the asset are less than the carrying value
The answer choice, “No, since the undiscounted cash flows are larger than the carrying value,” is wrong, but would be the rule under U.S. GAAP today, IFRS does not use undiscounted future cash flows.
The answer choice, “No, because the dock can be sold for its carrying value,” is wrong because IFRS uses net realizable value, not gross sale proceeds, for impairment tests. An asset is tested under IFRS for impairment, when there is reason to suspect loss in value. The test is to determine if the carrying value is recoverable. The recoverable amount is the greater of value in use (present value of discounted future cash flows) or net realizable value (sales proceeds less cost to sell). Here, that is $401,000 less the broker commission of $6,000, or $395,000. Since this is greater than the value in use ($380,000), the recoverable amount is $395,000, which is $5,000 below the carrying value, and thus A. A. recognizes an impairment loss of $5,000.
Which of the following statements regarding related party transactions is true?
Incorrect A.
Transactions between related parties cannot be presumed to have been carried out on an arm’s-length basis.
B.
Representations about transactions between related parties should not imply that they are equivalent to arm’s-length transactions unless such representations can be substantiated.
C.
Transactions between related parties cannot be presumed to have been carried out on an arm’s-length basis and representations about transactions between related parties should not imply that they are equivalent to arm’s-length transactions unless such representations can be substantiated.
D.
None of the answer choices are correct.
According to FASB ASC 850-10-50-5, transactions between related parties cannot be presumed to have been carried out on an arm’s-length basis. In addition, representations about transactions between related parties should not imply that they are equivalent to arm’s-length transactions unless such representations can be substantiated.
Midway Co. had the following transactions during 20X1:
•$1,200,000 pretax loss on foreign currency exchange due to a major unexpected devaluation by the foreign government
•$500,000 pretax loss from discontinued operations of a component
•$800,000 pretax loss on equipment damaged by a hurricane. This was the first hurricane ever to strike in Midway’s area. Midway also received $1,000,000 from its insurance company to replace a building, with a carrying value of $300,000, that had been destroyed by the hurricane.
What amount should Midway report in its 20X1 income statement as extraordinary loss before income taxes?
A.
$100,000
B.
$1,300,000
Incorrect C.
$1,800,000
D.
$2,500,000
FASB ASC 225-20-45-2 provides two criteria (unusual in nature and infrequent in occurrence) for extraordinary item treatment. Midway Co.’s hurricane loss appears to meet both of these criteria. So, Midway should report:
Extraordinary loss from hurricane (less applicable income taxes of $XXX) $XXXXX The amount of extraordinary loss before income taxes is $100,000:
(Loss on equipment and building - Proceeds from insurance)
($800,000 + $300,000 - $1,000,000) = $100,000
Note
The foreign currency exchange loss and loss from discontinued operations are specifically excluded from extraordinary treatment by FASB ASC 225-20-45-4.
Which of the following subsequent events must be recognized in the financial statements?
A.
Loss on an uncollectible trade account receivable as a result of a customer’s deteriorating financial condition leading to bankruptcy after the balance sheet date but before the financial statements are issued or are available to be issued
B.
Sale of a bond or capital stock issued after the balance sheet date but before financial statements are issued or are available to be issued
Incorrect C.
Changes in the fair value of assets or liabilities (financial or nonfinancial) or foreign exchange rates after the balance sheet date but before financial statements are issued or are available to be issued
D.
Settlement of litigation when the event giving rise to the claim took place after the balance sheet date but before financial statements are issued or are available to be issued
The correct answer is “loss on an uncollectible trade account receivable as a result of a customer’s deteriorating financial condition leading to bankruptcy after the balance sheet date but before the financial statements are issued or are available to be issued.” An entity must recognize in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet.
The other answer choices are incorrect because an entity must not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance
