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Flashcards in FAR 6 Deck (24):
1

Lew Co. sold 200,000 corrugated boxes for $2 each. Lew's cost was $1 per unit.
The sales agreement gave the customer the right to return up to 60% of the boxes within the first six months, provided an appropriate reason was given.
It was immediately determined, with appropriate reason, that 5% of the boxes would be returned. Lew absorbed an additional $10,000 to process the returns and expects to resell the boxes.

What amount should Lew report as operating profit from this transaction?

A. $170,000
B. $179,500
C. $180,000
D. $200,000

A. $170,000

Incorrect...

A is not correct. Net sales would be reduced by $20,000 (10,000 boxes x $2.00 each) for expected returns, but COGS also would be reduced by $10,000 (10,000 boxes x $1.00 each).
Thus, the net reduction in gross profit and operating profit would be $10,000, not $20,000.

C. $180,000

Correct!

Lew's operating profit is computed and explained as follows:

Sales 200,000 units x $2 selling price =
$400,000
Less: Provision for returns 200,000 x .05 x $2 = 20,000[1]
Net Sales = $380,000
COGS 200,000 units x $1 cost = $200,000
Less: Provision for returns 10,000 x $1 = 10,000
Net COGS 190,000 units x $1 = 190,000
Gross Profit $190,000
Less: Return processing cost 10,000[2]
Operating profit $180,000
[1] The facts state that 5% of the (all) boxes sold would be returned. The fact that 60% could be returned only established the maximum returnable rate, whereas 5% is the expected return rate.

[2] Since Lew has "absorbed" $10,000 to process returns, it has charged that amount to sales. The fact that Lew expects to resell the boxes is not recognized until the boxes are actually resold.

2

Brock Corp. reports operating expenses in two categories: (1) selling and (2) general and administrative. The adjusted trial balance at December 31, 20X5 included the following expense and loss accounts:
Accounting and legal fees $120,000
Advertising 150,000
Freight-out 80,000
Interest 70,000
Loss on the sale of long-term investments 30,000
Officers' salaries 225,000
Rent for office space 220,000
Sales salaries and commissions 140,000
One-half of the rented premises is occupied by the sales department.

Brock's total selling expenses for 20X5 are:

A. $480,000
B. $400,000
C. $370,000
D. $360,000

A. $480,000

Advertising $150,000
Freight-out 80,000
Rent for office space ($220,000 x .50) 110,000
Sales salaries and commissions 140,000
Equals total selling expenses $480,000
Advertising is part of the overall selling effort. Freight-out is delivery expense. Offering delivery service is also part of the overall sales effort. Only 1/2 the rent is included in selling expenses because the sales department occupies only 1/2 the premises.

3


Comprehensive income for a period is the:
A. Sum of other comprehensive income items for the period.
B. Change in total owners' equity from all sources, other than from transactions with owners acting as owners.
C. Sum of net income and other comprehensive income for the period.
D. Change in total owners' equity for the period.

C. Sum of net income and other comprehensive income for the period.

Comprehensive income is considered an overall measure of income and includes other comprehensive income. The latter is the net sum across four items: foreign currency adjustments, derivative gains and losses, unrealized gains and losses on securities available for sale, and certain pension adjustments. The latter four items are similar to income items but are not currently included in net income. Thus, comprehensive income is considered a broader and more inclusive measure of income than net income reported in the Income Statement.

4

Which of the following is a component of other comprehensive income?

A.
Minimum accrual of vacation pay.

B.
Cumulative currency-translation adjustments.

C.
Changes in market value of inventory.

D.
Unrealized gain or loss on trading securities.

B.
Cumulative currency-translation adjustments.

Comprehensive income reflects all changes from owner and nonowner sources. The other comprehensive income items are: unrealized G/L on AFS securities, unrealized G/L on pension costs, foreign currency translation adjustments, and unrealized G/L on certain derivative transactions.

5

Which of the following is included in other comprehensive income?
A. Unrealized holding gains and losses on trading securities.
B. Unrealized holding gains and losses that result from a transfer of a security from available-for-sale category to the trading category.
C. Foreign currency translation adjustments.
D. The difference between the accumulated benefit obligation and the fair value of pension plan assets.

Foreign currency translation adjustments are reported in other comprehensive income.

6

Burns Corp. had the following items:
Sales revenue $45,000
Loss on early extinguishment of bonds 36,000
Realized gain on sale of available-for-sale securities 28,000
Unrealized holding loss on available-for-sale securities 17,000
Loss on write-down of inventory 3,100
Which of the following amounts would the statement of comprehensive income report as other comprehensive income or loss?

A. $11,000 other comprehensive income.
B. $16,900 other comprehensive income.
C. $17,000 other comprehensive loss.
D. $28,100 other comprehensive loss

C. $17,000 other comprehensive loss.

Other comprehensive income is comprised of unrealized gains/losses on available-for-sale securities, minimum pension liability adjustment, foreign currency translation adjustment, and unrealized gains/losses on cash flow hedges. The only other comprehensive income item listed is the $17,000 unrealized gains/losses on available-for-sale securities

7

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
B. $10,000
C. $11,000
D. $17,000

B. $10,000

The components of comprehensive income are: Net Income, Unrealized gain/loss on AFS securities, foreign currency translation adjustment, unrecognized gain/loss on pension benefits, and deferred gain/loss on certain hedging transactions. Therefore, the Comprehensive income of Palmyra Co is $11,000 - 3,000 + 2,000 = $10,000.

8

A company reports the following information as of December 31:

Sales revenue $800,000
Cost of goods sold 600,000
Operating expenses 90,000
Unrealized holding gain on the available-for-sale securities, net of tax 30,000
What amount should the company report as comprehensive income as of December 31?

A. $30,000
B. $110,000
C. $140,000
D. $200,000

Comprehensive income is the sum of net income + OCI.

Comprehensive income (CI) is the sum of net income (NI) and other comprehensive income (OCI). In this case, NI = $110,000 ($800,000 sales - $600,000 CGS - $90,000 expenses). The unrealized holding gain is an item of OCI. There are four types of OCI items in all. This firm has only one of them. Thus, CI = $110,000 NI + $30,000 OCI = $140,000.

C. $140,000

9

When a full set of general-purpose financial statements are presented, comprehensive income and its components should:
A. Appear below income from continuing operations in the Income Statement.
B. Reported net of related income tax effect, in total and individually.
C. Appear in a supplemental schedule in the notes to the financial statements.
D. Be presented as part of the Income Statement or as a separate a financial statement following the Income Statement.

D. Be presented as part of the Income Statement or as a separate a financial statement following the Income Statement.

The components of comprehensive income are net income (or loss) plus/minus items of other comprehensive income, possibly including, for a period: (a) a minimum pension liability adjustment, (b) any unrealized gain or loss on available-for-sale investments, (c) a foreign currency translation adjustment and gain/loss on related hedge, and (d) the effective portion of cash flow hedges. U.S. GAAP requires that for-profit entities report comprehensive income and its components for a period (unless the entity has no items of other comprehensive income) in one of two statements:
1. as a separate "Statement of Comprehensive Income"
2. or combined with the Income Statement to provide a "Statement of Net Income and Comprehensive Income"

10

The accumulated other comprehensive income (AOCI) beginning balance for the current year was $6,000 dr. Net income for the period is $21,000. During the year the following two other comprehensive income items were recognized:
foreign currency translation loss, $2,000
and unrealized gain on securities available for sale, $9,000.
What amount is reported for comprehensive income (CI) for the year, and what is the ending AOCI balance?

CI AOCI
$7,000 $1,000 cr.
$28,000 $1,000 cr.
$21,000 $7,000 cr.
$28,000 $6,000 dr.

$28,000 $1,000 cr.


CI ($28,000) is the sum of income ($21,000) and other comprehensive income (-$2,000 + $9,000 = $7,000). AOCI is the running OE account, which is increased or decreased by other comprehensive income for the period. Ending AOCI = $6,000 dr. - $7,000 other comprehensive income (positive) = $1,000 cr. AOCI began the year with a new loss of $6,000 (debit balance), but the $7,000 positive other comprehensive income for the year turned the beginning dr. balance of AOCI into a net credit of $1,000.

11

Under FASB U.S. GAAP, which of the following items would cause earnings to differ from comprehensive income for an enterprise in an industry not having specialized accounting principles?
A. Unrealized loss on investments in noncurrent marketable equity securities.
B. Unrealized loss on investments in current marketable equity securities.
C. Loss on exchange of similar assets.
D. Loss on exchange of dissimilar assets.

A. Unrealized loss on investments in noncurrent marketable equity securities.


Unrealized gains and losses on securities available for sale are among the few items that appear in comprehensive income but not in earnings. Only SAS can be noncurrent. Assuming the current securities are classified as trading securities, then that unrealized loss is included in earnings.
This is a change in owners' equity that is not included in earnings and is not the result of a transaction with owners. It is an "other" comprehensive income item. "Other" refers to other than net income, which is the largest component of comprehensive income. The remaining items are recognized in income.

12

Rock Co.'s financial statements had the following balances at December 31:
Gain on the sale of equipment $ 50,000
Foreign currency translation gain 100,000
Net income 400,000
Unrealized gain on the available-for-sale equity securities 20,000
What amount should Rock report as comprehensive income for the year ended December 31?
A. $400,000
B. $420,000
C. $520,000
D. $570,000

C. $520,000

By definition, comprehensive income includes all changes in enterprise equity during a period except those changes resulting from transaction between the enterprise and its owners (e.g., investments by owners, dividends to owners, etc.). Therefore, comprehensive income includes net income plus/minus changes in equity that do not enter into the determination of net income (called items of "other comprehensive income").
Currently, there are four possible items of other comprehensive income:

1. minimum additional pension liability adjustment,

2.unrealized gains and losses on investments classified as available-for-sale (and certain other related unrealized gains/losses),

3.gains and losses resulting from translating financial statements expressed in a foreign currency (foreign currency translation) and losses/gains on related hedges,

4.and gains and losses on the effective portion of cash flow hedges.

For Rock Co. comprehensive income would be computed as:
Net income (includes the gain on sale) $400,000
Items of other comprehensive income:
Foreign currency translation gain 100,000
Unrealized gain on available-for-sale security 20,000
Comprehensive income $520,000

13

What is the purpose of reporting comprehensive income?

A.
To summarize all changes in equity from nonowner sources.

B.
To reconcile the difference between net income and cash flows provided from operating activities.

C.
To provide a consolidation of the income of the firm's segments.

D.
To provide information for each segment of the business.

A.
To summarize all changes in equity from nonowner sources.

The purpose of comprehensive income is to show all changes to equity, including changes that currently are not a required part of net income. Comprehensive income reflects all changes from owner and nonowner sources. The other comprehensive income items are: unrealized G/L on AFS securities, unrealized G/L on pension costs, foreign currency translation adjustments, and unrealized G/L on certain derivative transactions.

14

The Statement of Changes in Equity:

A.
Is one of the required financial statements under U.S. GAAP

B.
Includes accounts such as the retained earnings and common share accounts but not other comprehensive income items.

C.
Is used only if a corporation frequently issues common shares

D.
Reconciles all of the beginning and ending balances in the equity accounts.

D.
Reconciles all of the beginning and ending balances in the equity accounts.

The Statement of Changes in Equity reconciles all of the beginning and ending balances in the equity accounts. The statement shows the opening balance then details all changes in the accounts, ending with the closing balance.

15

The Statement of Changes in Equity shows an increase in the common stock account of $2,000 and an increase in the additional paid-in capital account of $10,000. If the common stock has a par value of $2, and the only transactions affecting these accounts were these issues of common stock, what was the average issue price of the common stock during the year?

A. $2

B. $5

C. $10

D. $12

D. $12

If the par value of the stock is $2, and the increase in the common stock account is $2,000, then $2,000/$2 = 1,000 shares issued. The average issue price is the sum of the par value ($2) and the additional paid-in capital ($10,000/1,000 shares, or $10), which totals $12.

16

Which of the following items would appear on the Statement of Owner's Equity?

Notes payable Treasury stock Advertising expense Retained earnings
Yes Yes Yes Yes
No Yes Yes Yes
No Yes No Yes
No No No N

No Yes No Yes

All changes in items affecting equity on the Balance Sheet are reported in the Statement of Owner's Equity. Both treasury stock and retained earnings are equity items.

17

Which of the following statements is false?

A.
A Statement of Cash Flows categorizes cash inflows and outflows into operating, investing, and financing activities.

B.
A Statement of Owner's Equity summarizes the changes in owner's equity for a specific period of time.

C.
An Income Statement summarizes the revenues, expenses, changes in owner's equity, and the resulting net income/loss for a specific period of time.

D.
A Balance Sheet reports the assets, liabilities, and owner's equity at a specific date.

C.
An Income Statement summarizes the revenues, expenses, changes in owner's equity, and the resulting net income/loss for a specific period of time.

The following statement is false: An Income Statement summarizes the revenues, expenses, changes in owner's equity, and resulting net income/loss for a specific period of time. Changes in owner's equity are reported in a separate statement and is not included in the Income Statement.

18

Which of the following information should be disclosed as supplemental information in the Statement of Cash Flows?
Cash flow per share Conversion of debt to equity
Yes Yes
Yes No
No Yes
No No


Cash flow per share Conversion of debt to equity

No Yes

Cash flow per share is specifically prohibited from being disclosed unless it is based on contractual amounts.
The conversion of debt to equity is an example of a transaction that would appear in the supplemental noncash disclosure schedule.

19

Bay Manufacturing Co. purchased a three-month U.S. Treasury bill.
In preparing Bay's Statement of Cash Flows, this purchase would:
A. Have no effect.
B. Be treated as an outflow from financing activities.
C. Be treated as an outflow from investing activities.
D. Be treated as an outflow from lending activities.

A. Have no effect.

The three-month bill meets the definition of a cash equivalent. Three months is the maximum original maturity under the definition. Cash and cash equivalents are the reporting basis of the Statement of Cash Flows. Cash decreased but cash equivalents increased the same amount as a result of this purchase. Thus, there is no net effect on cash and cash equivalents. Therefore, there is nothing to report in the Statement of Cash Flows.

20

Which of the following is not disclosed on the Statement of Cash Flows, either on the face of the statement or in a separate schedule, when prepared under the direct method?
A. The major classes of gross cash receipts and gross cash payments.
B. The amount of income taxes paid.
C. A reconciliation of net income to net cash flow from operations.
D. A reconciliation of ending retained earnings to net cash flow from operations


D. A reconciliation of ending retained earnings to net cash flow from operations.

The direct method Statement of Cash Flows must be supported by the supplemental disclosure of a reconciliation, but the reconciliation is of net income to net cash flow from operations, not retained earnings to net cash flow from operations. The ending retained earnings balance is not related to, and does not affect, operating cash flow.

21

The primary purpose of a Statement of Cash Flows is to provide relevant information about:
A. Differences between net income and associated cash receipts and disbursements.
B. An enterprise's ability to generate future positive net cash flows.
C. The cash receipts and cash disbursements of an enterprise during a period.
D. An enterprise's ability to meet cash operating needs.

C. The cash receipts and cash disbursements of an enterprise during a period.

This question provides an example of the need to read each answer alternative very carefully before choosing.
The Statement of Cash Flows is a listing of cash flows for a period in meaningful categories. Thus, it depicts the major cash receipts and disbursements during a period. Although such information may help a user to assess the ability of a firm to generate future cash flows, it does not, necessarily, say anything about the firm's ability to do so in the future.

Similarly, the cash flow statement does not directly indicate the firm's ability to meet future cash operating needs. The reconciliation of income and net operating cash flows does indicate the differences between income and operating cash flows, but this is not the primary purpose of the statement.

22

Which of the following sets of financial statements generally cannot be prepared directly from the adjusted trial balance?
A. Income Statement, Balance Sheet, Statement of Cash Flows.
B. Income Statement, Statement of Cash Flows.
C. Statement of Cash Flows.
D. Balance Sheet and Statement of Cash Flows.

C. Statement of Cash Flows.

This statement generally requires a significant amount of analysis to uncover the cash flows reported within. The adjusted trial balance presents ending account balances. The Statement of Cash Flows reports changes in cash by category. Cash flows are changes in cash and are categorized by type and reported in three categories: operating, investing, and financing.

23

Paper Co. had net income of $70,000 during the year. The dividend payment was $10,000. The following information is available:
Mortgage repayment $20,000
Available-for-sale securities purchased 10,000 increase
Bonds payable-issued 50,000 increase
Inventory 40,000 increase
Accounts payable 30,000 decrease

What amount should Paper report as net cash provided by operating activities in its Statement of Cash Flows for the year?
A. $0
B. $10,000
C. $20,000
D. $30,000

Operating Activities come from adjustments to reconcile net income to net cash flows and through analyzing the change in current asset and liability accounts. Net income - increase in inventory - decrease in accounts payable $70.000 - $40 000 - $30 000 = $0

A. $0

24

Mend Co. purchased a three-month U.S. Treasury bill. Mend's policy is to treat all highly liquid investments with an original maturity of three months or less when purchased as cash equivalents . How should this purchase be reported in Mend's Statement of Cash Flows?
A. As an outflow from operating activities.
B. As an outflow from investing activities.
C. As an outflow from financing activities.
D. Not reported.

D. Not reported.

The reporting basis of the Statement of Cash Flows is cash and cash equivalents. The purchase of a cash equivalent has no effect on the total of cash and cash equivalents. Such purchases increase cash equivalents and decrease cash by the same amount. Thus, the total of cash and cash equivalents is unaffected. This Treasury bill meets the definition of a cash equivalent. The Statement of Cash Flows reports changes in the fund defined as cash and cash equivalents. Thus, the purchase of this Treasury bill is not reported in the Statement of Cash Flows.