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Flashcards in FAR 31 - Costs and Expenses Deck (12):
1

On January 1, year 1, Alpha Co. signed an annual maintenance agreement with a software provider for $15,000 and the maintenance period begins on March 1, year 1. Alpha also incurred $5,000 of costs on January 1, year 1, related to software modification requests that will increase the functionality of the software. Alpha depreciates and amortizes its computer and software assets over five years using the straight-line method. What amount is the total expense that Alpha should recognize related to the maintenance agreement and the software modifications for the year ended December 31, year 1?

$13,500
This question has two costs that occurred during the year. You are asked how much of these costs would be recognized in year 1. The $15,000 of maintenance cost is for a 1 year period beginning March 1. The maintenance cost would be allocated 1/12 evenly over the life of the service period or $1,250 a month x 10 months in year 1 = 12,500. The $5,000 modification to the software has increased its functionality and therefore should be capitalized and amortized over the life of the software $5,000 / 5 years = $1,000/year. The total expense recognized in year 1 would be $12,500 + 1,000 = $13,500.

2

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?
A. Debit prepaid services and credit services expense for $30,000.
B. Debit prepaid services and credit services expense for $60,000.
C. Debit services expense and credit prepaid services for $30,000.
D. Debit services expense and credit prepaid services for $60,000.

B. 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.

3

On July 1, 2005, Ran County issued realty tax assessments for its fiscal year ended June 30, 2006.

On September 1, 2005, Day Co. purchased a warehouse in Ran County. The purchase price was reduced by a credit for accrued realty taxes. Day did not record the entire year's real estate tax obligation, but instead records tax expenses at the end of each month by adjusting pre-paid real estate taxes or real estate taxes payable, as appropriate. On November 1, 2005, Day paid the first of two equal installments of $12,000 for realty taxes.

What amount of this payment should Day record as a debit to real estate taxes payable?

$8,000
The total annual real estate tax is 2($12,000) or $24,000. Therefore, the tax per month is $2,000. Day assumed the taxes, already assessed on the property, for the full year.

The payment on November 1 covers the four months July, August, September, and October, for a total cost of $8,000. This portion of the $12,000 payment is debited to real estate taxes payable, because the full annual property tax amount is already accrued on Day's books from the purchase of the property. Pre-paid real estate taxes are debited for the remaining $4,000 of the payment.

The $4,000 pre-pays the tax for the next two months (November and December). At the end of each of those two months, the payable is debited for $2,000 and the pre-paid is credited for $2,000. The cycle begins again when the second payment is made. In this jurisdiction, the tax is assessed for a year at the beginning of the year.

Therefore, payments are debited to pre-paid real estate taxes unless previously accrued, as was the case here.

4

T/F: Under U.S. GAAP, direct response advertising costs can be capitalized.

True
But not under IFRS.

5

T/F: Both losses and expenses reduce earnings and provide a benefit to the firm.

False.
Both expenses and losses are debited when they are recognized and both reduce net income. Only expenses provide a benefit to the firm. Ex. salary expenses, rent expense, etc. all provide a benefit for the firm to continue operations.

6

T/F: Current accounting standards regarding research and development costs reflect the definition of an asset more than they reflect the matching principle.

True

7

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

Yes, 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.

8

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
A. Accrued if attributable to employees' services not already rendered.
B. Accrued if attributable to employees' services already rendered.
C. Accrued if attributable to employees' services, whether already rendered or not.
D. Recognized when paid.

B. 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.

9

T/F: A pay raise was granted between the time of accruing a compensated absence and paying it. The compensated absence liability, before it is paid, reflects the higher pay rate.

False.
The liability will be at the lower pay rate.

10

T/F: Compensated absences are recorded as expenses in the period paid if they are also earned by the employee that period.

True

11

T/F: If sick pay benefits are paid as a matter of course, they must be accrued when earned.

True

12

T/F: Vested vacation pay benefits do not carry over to future periods.

True

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