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Flashcards in FAR: ALL: 4/28/2018 Deck (15):

On January 1, 2002, Flax Co. purchased a machine for $528,000 and depreciated it by the straight-line method using an estimated useful life of eight years with no salvage value.

On January 1, 2005, Flax determines that the machine had a useful life of six years from the date of acquisition and will have a salvage value of $48,000. An accounting change is made in 2005 to reflect these additional data.

The accumulated depreciation for this machine should have a balance at December 31, 2005 of

1) $292,000

2) $308,000

3) $320,000

4) $352,000


This is a change in estimate. The new estimated useful life and salvage value are applied to the book value at the beginning of the year of the estimate change.

Accumulated depreciation, January 1, 2005 = $528,000(3/8) = $198,000
Book value, January 1, 2005 = $528,000 − $198,000 = $330,000 Depreciation, 2005 = ($330,000 − $48,000)/(6 − 3) = $94,000
Accumulated depreciation, 31 December 2005 $292,000
The denominator of the 2005 depreciation calculation (6 − 3) is the new total useful life of six years, less the three years for which the asset has been used as of January 1, 2005.


The stockholders of Meadow Corp. approved a stock-option plan that grants the company's top three executives options to purchase a maximum of 1,000 shares each of Meadow's $2 par common stock for $19 per share. The options were granted on January 1 when the fair value of the stock was $20 per share. Meadow determined that the fair value of the compensation is $300,000 and the vesting period is three years. What amount of compensation expense from the options should Meadow record in the year the options were granted?

1) $20,000

2) $60,000

3) $100,000

4) $300,000


The fair value of a fixed option plan at grant date is the fair value of the option. Typically the fair value of one option is given and that is multiplied by the number of options, but this problem provides the entire fair value. That total fair value is the total compensation expense to be recognized over the service period—the number of years from grant date to vesting. Once the options vest, no more compensation expense is recognized because the manager has provided the necessary service. Compensation expense per year is the total $300,000 compensation expense divided by 3 years, or $100,000 per year.


The following items relate to the preparation of a statement of cash flows:

Year 2 Year 1 Year 2
Cash $150,000 $100,000 Net sales $3,200,000
Equity sec. (FV) $40,000 0 CGS (2,500,000)
AR net 420,000 290,000 Expenses (500,000)
Inventory 330,000 210,000 Net income $ 200,000
Noncurrent assets 565,000 300,000
Accum. deprec. (5,000) (25,000)

All accounts receivable relate to trade merchandise. Cash discounts are not allowed to customers, but a service charge is added to an account for late payment. The allowance for doubtful accounts at the end of Year 2 was the same as the end of Year 1; no receivables were charged against the allowance during Year 2. Under investing activities, cash outflows during Year 2 totaled

1) $ 40,000.

2) $265,000.

3) $275,000.

4) $305,000.


Cash outflows from investing activities is comprised of the $265,000 increase in noncurrent assets ($565,000 − $300,000) plus the increase in equity securities of $40,000 for a total of $305,000.


On October 1, 2008, Buyco entered into a legally enforceable contract to acquire raw material inventory in 180 days for $20,000. In order to mitigate the risk of a change in the value of the raw materials, Buyco also entered into a qualified 180-day forward contract to hedge the fair value of the raw materials. At December 31, 2008, the value of the raw materials had decreased by $500, and the fair value of the futures contract had increased by $480. On March 29, 2009, the date the raw materials were delivered to Buyco, they had a fair value of $19,300, and the forward contract had a fair value of $700. Which one of the following is the amount of net gain or loss that would be recognized on the raw materials and related forward contract by Buyco in its 2008 net income?

1) $500

2) $480

3) $20

4) $ -0-


Because Buyco entered into the forward contract (hedging instrument) to hedge the risk of change in the fair value of the raw materials (hedged item), the change in fair value of the forward contract during 2008 offsets the change in the fair value of the raw materials. Specifically, the decrease in the value of the raw materials, $500, was offset by the increase in the value of the forward contract of $480, so the net loss recognized in 2008 was $500 − $480 = $20, which is the correct answer.


Eagle, Inc. is a manufacturer and distributor of consumer products in the U.S. It has a wholly owned foreign subsidiary, El Rio, which sells Eagle products in Mexico. El Rio receives all of its products from Eagle, sells those products, and remits the proceeds to Eagle. El Rio maintains its books and prepares its financial statements in the Mexican peso. Which one of the following methods will Eagle most likely use to convert El Rio's financial statements to dollar-based statements?

1) Translation.

2) Remeasurement.

3) Translation and then remeasurement.

4) Remeasurement and then translation.


Because El Rio's operations are a direct extension of Eagle, the peso is not El Rio's functional currency; Eagle's currency, the U.S. dollar, is El Rio's functional currency. Therefore, El Rio's financial statements will be converted to U.S. dollars using remeasurement.


Arrow Company purchased a machine on January 1, year 1, for $1,440,000 for the purpose of leasing it. The machine is expected to have an 8-year life from date of purchase, no residual value, and be depreciated on the straight-line basis. On February 1, year 1, the machine was leased to Baxter Company for a 3-year period ending January 31, year 4, at a monthly rental of $30,000. Additionally, Baxter paid $72,000 to Arrow on February 1, year 1, as a lease bonus. What is the amount of income before income taxes that Arrow should report on this leased asset for the year ended December 31, year 1?

1) $172,000

2) $187,000

3) $222,000

4) $237,000


Income from the lease is the monthly rental plus a proportionate fraction of the lease bonus less any depreciation expense.

Rental income = 11 months × $30,000 = $ 330,000
Lease bonus income = $72,000 × 11/36 = $ 22,000
Depreciation expense = $1,440,000/8 years = $(180,000)
Income from leased asset $ 172,000

Note that the lease bonus is recognized as income proportionately over the 36-month lease period. The leased asset is depreciated for a full year since it has an 8-year life from the date of purchase (January 1).


On December 12, 20X8, Averseco entered into a forward exchange contract to purchase 100,000 units of a foreign currency in 90 days. The contract was designated as and qualified as a fair value hedge of a purchase of inventory made that day and payable in March 20X9. The relevant direct exchange rates between the foreign currency and the dollar are as follows:

Spot Rate Forward Rate
(for March 12, 20X9)
December 12, 20X8 $0.88 $0.90
December 31, 20X8 0.98 0.93
At December 31, 20X8, what amount of foreign currency transaction net gain or loss should Averseco recognize in income as a result of its foreign currency obligation and related hedge contract? (Ignore premium/discount and present value considerations.)

1) $-0-

2) $3,000

3) $7,000

4) $10,000


The net loss will be $7,000. The gain or loss on the payable will be measured as the number of foreign currency units multiplied by the change in the spot rate between the date the liability arose, December 12, and the end of the year, December 31. Thus, the loss on the payable will be 100,000 foreign currency units × ($0.98 − $0.88 = $0.10) = $10,000. The gain or loss on the forward contract (disregarding any premium/discount at initiation of the contract and without using a present value factor) will be measured as the number of foreign currency units multiplied by the change in the forward rate between the date the contract was executed, December 12, and the end of the year, December 31. Thus, the gain on the forward contract will be 100,000 foreign currency units × ($0.93 − $0.90 = .03) = $3,000. The net will be $10,000 − $3,000 = $7,000, the correct answer.


The test for recoverability of operational assets per ASC Topic 360 uses

1) Undiscounted cash inflows less related outflows.

2) Discounted cash inflows less related outflows.

3) Discounted cash inflows only.

4) Undiscounted cash inflows only.

Undiscounted cash inflows less related outflows

This answer is correct because if circumstances indicate that the carrying amount of an asset may not be recoverable, an entity shall estimate the future cash flows expected to result from the use of the asset and its eventual disposition. Future cash flows are defined as the undiscounted future cash inflows less the undiscounted future cash outflows necessary to obtain those inflows. Note that the use of undiscounted cash flows in the recoverability test is consistent with the measurement of property, plant, and equipment at historical cost which is an undiscounted amount.


A subsidiary's functional currency is the local currency which has not experienced significant inflation. The appropriate exchange rate for translating the depreciation on plant assets in the income statement of the foreign subsidiary is the:

1) Exit exchange rate.

2) Historical exchange rate.

3) Weighted average exchange rate over the economic life of each plant asset.

4) Weighted average exchange rate for the current year.

Weighted average exchange rate for the current year

The weighted average exchange rate for the current year is the correct rate to use to convert depreciation expense. Since the functional currency is the local currency, the income statement of the subsidiary would be converted using translation, which requires the use of the exchange rate when a revenue/gain was earned or expense/loss was incurred, or the weighted average exchange rate for the year. Since depreciation expense is incurred throughout the year, the weighted average exchange rate normally is the appropriate basis for conversion.


Album Co. issued 10-year $200,000 debenture bonds on January 2. The bonds pay interest semiannually. Album uses the effective interest method to amortize bond premiums and discounts. The carrying value of the bonds on January 2 was $185,953. A journal entry was recorded for the first interest payment on June 30, debiting interest expense for $13,016 and crediting cash for $12,000. What is the annual stated interest rate for the debenture bonds?

1) 6%

2) 7%

3) 12%

4) 14%


The stated rate determines the cash interest paid. $12,000/$200,000 = 6% for the six-month period, or 12% for the annual period. The stated rate is applied to the face value of the bonds, regardless of their price at issuance.


Acme Co.'s accounts payable balance at December 31 was $850,000 before necessary year-end adjustments, if any, related to the following information:

At December 31, Acme has a $50,000 debit balance in its accounts payable resulting from a payment to a supplier for goods to be manufactured to Acme's specifications.

Goods shipped F.O.B. destination on December 20 were received and recorded by Acme on January 2. The invoice cost was $45,000.

In its December 31 balance sheet, what amount should Acme report as accounts payable?

1) $850,000

2) $895,000

3) $900,000

4) $945,000


The $50,000 advance is not related to accounts payable, even though it was made to a supplier for which Acme would have accounts payable. It is a prepayment. Removing the $50,000 debit increases the accounts payable balance by that amount. The $45,000 shipment is not part of the inventory of Acme as of December 31 nor is it a liability (accounts payable) because title to the goods did not transfer to Acme until January 2. FOB destination means that title does not transfer until goods reach their destination. Acme treated this item correctly because it was recorded January 2. Therefore, the correct accounts payable balance is $900,000 ($850,000 before adjustment + $50,000).


Fireworks, Inc., had an explosion in its plant that destroyed most of its inventory. Its records show that beginning inventory was $40,000. Fireworks made purchases of $480,000 and sales of $620,000 during the year. Its normal gross profit percentage is 25%. It can sell some of its damaged inventory for $5,000. The insurance company will reimburse Fireworks for 70% of its loss. What amount should Fireworks report as loss from the explosion?

1) $50,000

2) $35,000

3) $18,000

4) $15,000


To calculate the loss, you must first determine an estimate of the inventory on hand, and information is provided to estimate the inventory based on the gross profit method. If the gross profit percent is 25% of sales, an estimate of the loss may be calculated as shown below:

Sales $620,000
COGS (75%) (465,000)
Gross Profit 25% $155,000
Beginning inventory $ 40,000
+ Purchases 480,000
Goods avail. for sale $520,000
− Cost of goods sold (estimated) (465,000)
Ending inventory (estimated) $ 55,000

Ending inventory (estimated) $ 55,000
Less: sales value of damaged goods (5,000)
Estimated loss $ 50,000
× 30% (not reimbursed) × 30%
Amount of loss not reimbursed $ 15,000

Therefore, this is correct.


On December 31, 2004, 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, 2004 balance sheet, what amount should Dirk report as deferred gain on these transactions?

1) $950,000

2) $500,000

3) $450,000

4) $0


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.


Based upon its past collection experience, Alden Company provides for bad debt expense at the rate of 2% of credit sales. On January 1, year 1, the allowance for doubtful accounts balance was $10,000. During year 1 Alden wrote off $18,000 of uncollectible receivables and recovered $5,000 of bad debts written off in prior years. If credit sales for year 1 totaled $1,000,000, the allowance for doubtful accounts balance at December 31, year 1, should be

1) $12,000

2) $17,000

3) $20,000

4) $30,000


The ending balance of the allowance for doubtful accounts includes the Beginning balance + Recoveries of bad debts written off in prior years + Current year’s bad debt expense − Write-offs of uncollectibles. The beginning balance was $10,000 and write-offs (debits) were $18,000. Recoveries of bad debts written off in prior years ($5,000) would be a credit to the allowance account and a debit to accounts receivable. Finally, the credit to the allowance account for bad debts expense would be $20,000 (2% of $1,000,000), leaving a 12/31/year 1 balance of $17,000.


On January 1, year 1, Rodriguez Corp. granted stock options to corporate executives for the purchase of 10,000 shares of the company’s $20 par value common stock at 70% of the market price on the exercise date, December 30, year 1. On January 1, year 1, no market price or estimate could be made for the value of the options. All stock options were exercised on December 30, year 1. The quoted market prices of Rodriguez Corp.’s $20 par value common stock were as follows:

January 1, year 1 $50 per share
December 30, year 1 $60 per share
As a result of the exercise of the stock options and the issuance of the common stock, Rodriguez should recognize compensation expense in year 1 of

1) $180,000

2) $200,000

3) $500,000

4) $600,000


When there is no observable market price of the option or estimate of the value of the option, the intrinsic value is measured at the end of each reporting period. The intrinsic value of the option is net of any amounts that the employee must pay. The employees must pay 70% of the value of the stock on the exercise date. Therefore, the employees will pay 70% × $60 = $42 per share. On the exercise date, the compensation expense recognized is $60 − $42 = $18 × 10,000 options = $180,000.