FAR3 Flashcards

Question 1

Q

What is the designation of the investee

in a business combination?

Answer

A

Subsidiary company

Question 2

Q

Define/describe a “legal merger.”

Answer

A

One entity acquires either a group of
assets constituting a business or a
controlling interest of another entity
and "collapses" the acquired
assets/entity into the acquiring
company

Question 3

Q

Describe how income is determined at

the date of a combination.

Answer

A

Only the acquirer’s operating results up
to the date of combination enter into
determination of “consolidated” net
income

Question 4

Q

What may be acquired in a business

combination?

Answer

A

A business entity acquires either a
group of net assets that constitutes a
business or equity interest in an entity.

Question 5

Q

Define “parent company” as it relates

to business combinations.

Answer

A

Designation of the investor in a

business combination

Question 6

Q

List the three legal forms of business

combinations.

Answer

A

Merger
Consolidation
Acquisition

Question 7

Q

List the primary means of

accomplishing a business combination.

Answer

A

The acquisition by one entity of the
common stock of another entity to gain
control of the investee

Question 8

Q

Describe how income is determined at

the end of the year for a combination.

Answer

A

The acquirer's operating results for the
year plus the acquiree's operating
results after the combination enter into
the determination of consolidated
income for the year of combination.

Question 9

Q

Define/describe a “legal acquisition.”

Answer

A

One entity acquires controlling interest
of another entity, but both continue to
exist and operate as separate legal
entities

Question 10

Q

Identify the legal forms of business
combination that will not require
preparation of consolidated financial
statements.

Answer

A

A legal merger or a legal consolidation
will not require preparation of
consolidated financial statements.
Only a legal acquisition will require
preparation of consolidated financial
statements.

Question 11

Q

Define/describe a “legal

consolidation.”

Answer

A

A new entity is formed to combine
(consolidate) two or more preexisting
entities.

Question 12

Q

Describe how income is determined for

subsequent years of a combination.

Answer

A

The acquirer’s and the acquiree’s
operating results enter into the
determination of consolidated net
income.

Question 13

Q

In which of the following legal forms of business combination does at least one preexisting entity cease to exist?

Merger
Consolidation
Acquisition

Answer

A

Merger - YES
Consolidation - YES
Acquisition - NO

In a merger and a consolidation, at least one preexisting entity ceases to exist, but in an acquisition, no entity ceases to exist. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities. In a legal merger, one preexisting entity is combined into another preexisting entity; one entity ceases to exist. In a legal consolidation, two or more existing entities are combined into one new entity; two or more entities cease to exist.

Question 14

Q

In which of the following legal forms of business combination are the assets and liabilities of an acquired entity or entities recorded on the books of the acquiring entity?
Merger
Acquisition
Consolidation

Answer

A

Merger - YES
Acquisition - NO
Consolidation - YES

n a merger and in a consolidation, the assets and liabilities of the acquired entity/entities are recorded on the books of the acquiring entity, but in an acquisition, the assets and liabilities of the acquired entity remain on the books of the acquired entity. In a merger and in a consolidation, at least one preexisting entity ceases to exist, and the assets and liabilities are recorded on the books of the surviving entity. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities.

Question 15

Q

On December 1, 200X, Betaco agreed to be acquired 100% by Alphaco at a cost equal to Betaco’s book value. The combination was initiated at that time, and the closing date for the acquisition was December 31, 200X. Both firms have December 31 fiscal year-ends. There were no other transactions between the firms during 200X or 200Y. Each firm had the following net incomes for the periods shown:

                                  Alphaco	 Betaco 1/1/0X–11/30/0X	    $20,000	$5,000 12/1/0X–12/31/0X	        4,000	   1,000 1/1/0Y–1/31/0Y	                2,000	  3,000

Which one of the following is the consolidated net income that Alphaco should recognize for 200X?

Answer

A

$24,000

The consolidated net income recognized by Alphaco for 200X would be its net income only. Therefore, the amount would be $20,000 for January 1 through November 30 and $4,000 for December, or a total of $24,000. Betaco’s net income before the closing of the combination (the acquisition date) would not be included in consolidated net income. Basically, Betaco’s net income for all of 200X was “paid for” by Alphaco in the consideration it transferred to acquire Betaco.

Question 16

Q

In which of the legal forms of business combination does more than one entity survive?
Merger
Consolidation
Acquisition

Answer

A

Merger - No
Consolidation - No
Acquisition - YES

Only in a legal acquisition does more than one entity survive. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities. In a legal merger, one preexisting entity is combined into another preexisting entity; only one entity survives. In a legal consolidation, two or more existing entities are combined into one new entity; only the new entity survives.

Question 17

Q

In which of the following legal forms of business combination are two or more entities combined into one new entity?
Merger
Consolidation
Acquisition

Answer

A

Merger - No
Consolidation - Yes
Acquisition - No

Only a legal consolidation results from the combination of two or more existing entities into one new entity. In a merger, one preexisting entity is combined into another preexisting entity; no new entity is formed. In an acquisition, one preexisting entity acquires controlling interest in another preexisting entity, and both continue to exist as separate legal entities; no new entity is formed.

Question 18

Q

Topco owns 60% of the voting common stock of Midco and 40% of the voting common stock of Botco. Topco wishes to gain control of Botco by having Midco buy shares of Botco’s voting stock. Which one of the following minimum levels of ownership of Botco must Midco additionally need to obtain in order for Topco to have controlling interest of Botco’s voting stock?

Answer

A

11%

In order for Topco to gain control of Botco, it must own, either directly or indirectly, more than 50% of Botco’s voting stock. Since it directly owns 40% of Botco’s voting stock, it must acquire control over 10+% more. Also, since Topco owns 60% of Midco, it controls Midco. Therefore, if Midco acquires 11% of Botco, Topco will be able to exercise 51% of Botco’s voting stock — 40% directly and 11% indirectly through its control of Midco.

Question 19

Q

On December 1, 200X, Betaco agreed to be acquired 100% by Alphaco at a cost equal to Betaco’s book value. The combination was initiated at that time, and the closing date for the acquisition was December 31, 200X. Both firms have December 31 fiscal year-ends. There were no other transactions between the firms during 200X or 200Y. Each firm had the following net incomes for the periods shown:

                                 Alphaco	Betaco 1/1/0X–11/30/0X	    $20,000	$5,000 12/1/0X–12/31/0X	         4,000	   1,000 1/1/0Y–1/31/0Y	                 2,000	  3,000

Which one of the following is the amount of consolidated net income that should be recognized for January 200Y?

Answer

A

$5,000

The correct amount is Alphaco’s net income for January 200Y ($2,000) plus Betaco’s net income for the period ($3,000), or $5,000. Income earned by the firms during 200X would not enter into 200Y income determination under any assumption.

Question 20

Q

On October 1, 200X, Parco acquired 100% controlling interest of Setco in a legal acquisition. There were no other transactions between the entities during 200X. The two companies reported the following net incomes/(losses) for the periods shown:

                               Parco	        Setco 1/1/0X - 9/30/0X	 $125,000	$40,000 10/1/0X - 12/31/0X	  30,000	        ($15,000)

Which one of the following would be the amount of income recognized by Parco in its consolidated financial statements for the year ended December 31, 200X?

Answer

A

$140,000

Consolidated income for the year ended December 31, 200X, would consist of Parco’s net income for the full year ($125,000 + $30,000 = $155,000) plus Setco’s net loss for the period following its acquisition by Parco ($15,000 loss). Therefore, Parco’s net income for the full year would be $155,000 − $15,000 = $140,000.

Question 21

Q

What method is required to be used in
accounting for most business
combinations?

Answer

A

Acquisition method

Question 22

Q

List the business combinations for
which the acquisition method of
accounting does not apply.

Answer

A

Joint ventures

Entities under common control

Between not-for-profit
organizations

For-profit entity acquired by a
not-for-profit organization

Acquisition of assets that do not
constitute a business

Question 23

Q

List the five elements (or steps)
involved in applying the acquisition
method of accounting to a business
combination.

Answer

A

Identify the acquirer.
Determine the acquisition date
and measurement period.
Determine the cost of the
acquisition.
Recognize and measure the
identifiable assets acquired,
liabilities assumed, and any
noncontrolling interest in the
acquired entity.
Recognize and measure goodwill
or a gain from a bargain
purchase.

Question 24

Q

Define “acquisition date.”

Answer

A

The date on which the acquirer obtains
control of another business (i.e., group
of assets that constitute a business or a
separate legal entity). It usually is also
the “closing date” for the combination.

Question 25

Q

Define “measurement period.”

Answer

A

The period after the acquisition date
during which the acquirer may adjust
any provisional amounts recorded at
the acquisition date. It provides the
acquirer reasonable time to obtain
information needed to identify and
measure accounts and amounts that
existed as of the acquisition date. It
ends when the acquirer obtains that
information or determines that no
additional information is available, but
in no case should it exceed one year.

Question 26

Q

When a business combination is
effected through an exchange of equity
interest, what are five factors to
consider that indicate which entity is
the acquirer?

Answer

A

Which combining entity/entities:
1. Issued new equity interest.
2. Owners have the larger portion of
the voting rights.
3. Owners can select or remove a
voting majority of the governing
body.
4. Former management dominates
that of the combined entity.
5. Paid a premium over the
precombination fair value of the
equity interest of the other
combining entities.

Question 27

Q

For the purposes of applying the
acquisition method to a business
combination, what may constitute a
“business”?

Answer

A

A business may be:
1. A group of assets or a group of
net assets (that constitute a
business).
2. A separate legal entity (that is a
business).

Question 28

Q

Which one of the following would be subject to the acquisition accounting requirements of ASC 805, Business Combinations?

Answer

A

Acquisition of a manufacturing entity by a holding company

The acquisition of a manufacturing entity by a holding company would be subject to the acquisition accounting requirements of ASC 805. The formation of a joint venture, the acquisition of assets that do not constitute a business, a combination between entities under common control, a combination between not-for-profit organizations, and the acquisition of a for-profit entity by a not-for-profit organization are the only combinations specifically excluded from the scope of ASC 805.

Question 29

Q

If a business combination is effected through an exchange of equity interests, assuming all other factors are equal, which one of the following independent circumstances would not indicate the likely acquirer in a business combination?

Answer

A

The combining entity whose debt-holders have the larger portion of the debt of the combined entity

Because debt-holders do not have voting rights and cannot exercise control over an investee, the combining entity whose debt-holders have the larger portion of the debt of the combined entity by itself would not indicate that the entity is an acquirer in a business combination.

Question 30

Q

The requirements of ASC 805, Business Combinations, apply to all of the following business combinations except for which one?

Answer

A

Combination between not-for-profit organizations

The requirements of ASC 805 do not apply to combinations between not-for-profit organizations (or to the formation of a joint venture, an acquisition of assets that do not constitute a business, a combination of entities under common control, or the acquisition of a for-profit entity by a not-for-profit organization).

Question 31

Q

At the closing date of a business combination, goodwill was recognized. During the subsequent measurement period, additional identifiable assets were properly recognized as part of the business combination. If no other changes occurred during the measurement period, which one of the following would be the effect, if any, of the additional assets recognized on the amount of goodwill recognized in the combination?

Answer

A

A decrease in the amount of goodwill recognized

The recognition of additional identifiable assets would result in a decrease in the amount of goodwill initially recognized in a business combination. Since goodwill is basically the difference (residual) between the investment fair value and the fair value of the net identifiable assets acquired, an increase in the identifiable assets will result in a decrease in the amount of goodwill.

Question 32

Q

Which of the following statements concerning the acquisition date of a business combination is/are correct?

I. The acquisition date may be before the closing date.

II. The acquisition date may be on the closing date.

III. The acquisition date may be after the closing date.

Answer

A

I, II, and III.

All three statements are correct. The acquisition date may be before the closing date, on the closing date, or after the closing date, if by agreement or otherwise the acquirer gains control of the acquiree at an earlier or later date than the closing date.

Question 33

Q

When using the acquisition method of accounting for a business combination, which of the following statements concerning the measurement period is/are correct?

I. It provides time for the acquiring entity to identify assets acquired and liabilities assumed that existed as of the acquisition date.

II. It provides time for the acquiring entity to determine the fair value of assets acquired and liabilities assumed that existed as of the acquisition date.

III. It should not exceed one year from the acquisition date.

Answer

A

I, II, and III.

All three statements are correct. The measurement period provides time for the acquiring entity to identify assets acquired and liabilities assumed (Statement I), to determine the fair value of those assets and liabilities (Statement II), both as of the acquisition date, and is limited to one year from the acquisition date (Statement III).

Question 34

Q

Which of the following statements concerning the nature of an acquired business in a business combination is/are correct?

I. A business may be a group of assets.

II. A business may be a group of net assets.

III. A business may be a separate legal entity.

Answer

A

I, II, and III.

All three statements are correct. A business may be a group of assets (that constitute a business), a group of net assets (that constitute a business), or a separate legal entity (that is a business).

Question 35

Q

Which one of the following is not a characteristic associated with the concept of a “business” for the purposes of ASC 805, Business Combinations?

Answer

A

Must be in the form of a separate legal entity

For the purposes of ASC 805, a business does not have to be in the form of a separate legal entity. Specifically, a business is an integrated set of activities and assets that is capable of being conducted and managed through the use of inputs and processes for the purpose of providing economic benefits to owners, members, or participants. The concept of a “business” for the purposes of ASC 805 does not have to be in the form of a separate legal entity. Under this definition, a “business” may be a group of assets (or net assets) that constitute a business (e.g., a line of business) and does not have to be in the form of a separate legal entity.

Question 36

Q

Zipco, Inc. acquired 100% of the voting stock of Narco, Inc. with an acquisition date of March 31, 2009. During the following three months, Zipco learned the following:

I. A major credit customer of Narco had declared bankruptcy on March 1, 2009, but the adverse effect on Narco’s accounts receivable had not been recognized in the amount of accounts receivable recognized in the acquisition date amounts.

II. Narco had a lawsuit against it that existed at the acquisition date of the combination but was not recognized on Narco’s books or in the liabilities recognized at the acquisition date. Analysis determined that it was more likely than not that the party that brought the lawsuit would win a material judgment against Narco/Zipco.

Which of these items of new information, if any, should be recognized in accounting for the business combination?

Answer

A

Both I and II.

The effects of both the reduced accounts receivable and the lawsuit liability would be recognized in accounting for the business combination. Since the effects on Narco’s accounts receivable and the lawsuit liability both occurred before the acquisition date, both items would be recognized in accounting for the business combination and would be adjustments made during the measurement period. The effects would be to reduce accounts receivable (Item I) and to increase liabilities (Item II) in the final recording of the business combination.

Question 37

Q

Which of the following are requirements of using the acquisition method of accounting for a business combination?

I. Determining the acquiring entity.

II. Determining the acquisition date of the business combination.

III. Determining the cost of the acquisition.

Answer

A

I, II, and III.

Determining the acquiring entity (Statement I), determining the acquisition date of the combination (Statement II), and determining the cost of the acquisition (Statement III), and other elements, are all requirements of the acquisition method of accounting for a business combination.

Question 38

Q

Which one of the following correctly describes the maximum length of the measurement period for a business combination?

Answer

A

One year from the acquisition date of the combination

The measurement period may extend up to one year from the acquisition (closing) date of a business combination. The measurement period is the period after the acquisition date during which the acquirer may adjust any provisional amounts recognized as part of the business combination, and it may extend for as long as one year after the acquisition date.

Question 39

Q

Company Z is formed to consolidate three preexisting entities: Companies W, X, and Y. Company Z pays cash to acquire the net assets of Company W and issues debt to acquire the net assets of Company X. Company Z acquires all of the stock of Company Y in the market for cash. Which one of the companies is most likely the acquirer in the business combination?

Answer

A

Company Z

Because Company Z only paid cash and issued debt to effect the combination (no new equity was issued to effect the combination), Company Z is most likely the acquirer.

Question 40

Q

Which of the following statements, if any, concerning the accounting for business combinations is/are correct?

I. All business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805, Business Combinations.

II. The acquisition accounting requirements of ASC 805, Business Combinations, are identical to those of IFRS #3, Business Combinations.

Answer

A

Neither I nor II.

Neither statement is correct. Not all business combinations in the U.S. are subject to the acquisition accounting requirements of ASC 805 (Statement I). That pronouncement specifically excludes certain combinations, including the formation of a joint venture, the acquisition of assets that do not constitute a business, a combination between entities under common control, a combination between not-for-profit organizations, and the acquisition of a for-profit entity by a not-for-profit organization. In addition, the requirements of ASC 805 are not identical to those of IFRS #3 (Statement II). Differences exist between the two pronouncements in the areas of scope; the definition of control; how fair value, contingencies, employee benefit obligations, noncontrolling interest, and goodwill are measured; and disclosure requirements.

Question 41

Q

In which one of the following cases is Company A most likely to be the acquirer of Company B in a business combination?

Answer

A

Company A owns 35% of Company B’s voting stock and 60% of Company C’s voting stock, which owns 20% of Company B’s voting stock.

Generally, to be an acquirer, an entity must own, either directly or indirectly, more than 50% of the voting stock of another entity. In this case, Company A owns 35% of Company B directly and would control 20% indirectly, or a total of 55%. (Since Company A owns 60% of Company C, it has absolute control of C and could control C’s 20% ownership of B.) Thus, Company A would control Company B and likely would be an acquirer in a business combination.

Question 42

Q

When a new entity is formed to effect a business combination, which of the following statements, if any, is/are correct?

I. A legal consolidation has occurred.

II. The new entity is always the acquirer in the business combination.

Answer

A

I only.

Statement I is correct; Statement II is not correct. When a new entity is formed to effect a business combination, a legal consolidation has occurred (Statement I), but the new entity is not always the acquirer in the combination (Statement II). If the new entity transfers cash or other assets or incurs liabilities to effect the combination, the new entity is likely the acquirer, but if the new entity issues equity interest to effect the business combination, one of the pre-existing combining entities must be the acquirer.

Question 43

Q

Which of the following is/are acceptable methods to account for a business combination?
Purchase Method
Acquisition Method
Pooling of Interests Method

Answer

A

Purchase Method - No
Acquisition Method - Yes
Pooling of Interests Method - No

Only the acquisition method is acceptable in accounting for a business combination. The purchase method and the pooling of interests method of accounting for a business combination are not acceptable methods. The pooling of interests method was eliminated in 2001 and the purchase method was changed to the acquisition method in 2008. Although the acquisition method is a variation of the purchase method, it has sufficiently different requirements that it is not identified as the “purchase method,” but rather as the “acquisition method.”

Question 44

Q

The acquisition date of a business combination is generally which one of the following?

Answer

A

The closing date

The acquisition date of a business combination is the date on which the acquiring entity obtains control of the acquired business; usually, it is also the closing date (of the business combination).

Question 45

Q

Under what circumstance is fair value
not used to measure assets and
liabilities transferred in a business
combination?

Answer

A

When the assets and liabilities are
transferred to the acquiree but remain
under the control of the acquirer
because the acquirer obtained control
of the acquiree (which holds the
transferred asset or liability). In such a
case, the asset or liability should be
transferred at carrying value, not fair
value.

Question 46

Q

How is the exchange of share-based
employee awards treated in a business
combination?

Answer

A

If the exchange is required:

The portion of the value of the
replacement awards that relates
to precombination services is
part of the cost of the acquired
business.

The portion of the value of the
replacement awards that relates
to postcombination services is
expensed.

If the exchange is voluntary, the value
of the replacement awards is expensed.

Question 47

Q

List the elements that make up the cost

of an acquired business.

Answer

A

Fair value of:
Assets transferred
Liabilities incurred
Equity interest issued
Contingent consideration
obligations of the acquirer
Required share-based employee
awards for precombination
services

Question 48

Q

Describe the nature of contingent
consideration in a business
combination.

Answer

A

Contingent consideration is either:

An obligation of the acquirer to
transfer additional assets or
equity to the former owners of
the acquired business if future
conditions are met; or

A right of the acquirer to a return
of previously transferred
consideration if future conditions
are met.

Contingent consideration is recognized
at fair value as of the acquisition date
as part of the cost of the acquiree.

Question 49

Q

A company acquires another company for $3,000,000 in cash, $10,000,000 in stock, and the following contingent consideration:

$1,000,000 after Year 1, $1,000,000 after Year 2, and $500,000 after year 3, if earnings of the subsidiary exceed $10,000,000 in each of the three years.
The fair value of the contingent -based consideration portion is $2,100,000. What is the total consideration transferred for this business combination?

Answer

A

$15,100,000

All consideration, including contingent consideration, must be measured at acquisition date fair value. The total consideration transferred is:
Cash	$ 3,000,000
Stock	10,000,000
Contingent consideration	2,100,000
Total	$15,100,000

Question 50

Q

An obligation of an acquirer to pay contingent consideration to the former owners of an acquired entity in a business combination can be recognized as which of the following?
A Liability
An Equity Item

Answer

A

A Liability - Yes
An Equity Item - Yes

An obligation to pay contingent consideration in a business combination may be recognized by the acquirer as either a liability or as an equity item, depending on the nature of the obligation under the provisions of ASC 480, Distinguishing Liabilities from Equity.

Question 51

Q

Changes in the fair value of contingent consideration transferred in a business combination resulting from occurrences after the acquisition date should be recognized as a gain or loss in the current income when the contingent consideration is classified as
An Asset or a Liability
An Equity Item

Answer

A

An Asset or a Liability - Yes
An Equity Item - No

Changes in the fair value of contingent consideration resulting from occurrences that occur after the acquisition date are recognized as gains or losses when the contingent consideration is classified as an asset or a liability. Contingent considerations classified as equity are not remeasured, and no gain or loss is recognized. The change in fair value of equity items is recognized as an adjustment within equity.

Question 52

Q

Which of the following statements concerning the acquisition of a business is/are correct?

I. Most consideration transferred to effect a business combination should be measured at fair value.

II. Contingent consideration should be included in the cost of an acquired business at fair value existing on the acquisition date.

III. The cost of carrying out a business combination should be included in the cost of an acquired business.

Answer

A

I and II only.

Statement I and Statement II are correct; Statement III is not correct. Most consideration used to effect a business combination should be measured at fair value (Statement I). The only exception is when the consideration transferred remains under the control of the acquirer. Contingent consideration should be included in the cost of an acquired business at fair value as of the acquisition date (Statement II). The cost of carrying out a business combination should not be included in the cost of an acquired business (Statement III); most such costs should be expensed.

Question 53

Q

The terms of a business combination can provide that former shareholders of the acquired firm may receive additional compensation based on post-combination earnings or post-combination market share price. Would additional compensation based on such earnings or market price be considered an additional cost of the business combination?
Based on Earnings
Based on Share Price

Answer

A

Based on Earnings - No
Based on Share Price - No

Additional compensation to former shareholders of an acquired entity based on either post-combination earnings or post-combination share price would not be recognized as changes in the cost of the business combination. Changes in the fair value of contingent consideration resulting from occurrences after the acquisition date, including meeting earnings targets and reaching a specified share price, are not measurement period adjustments and do not enter into the cost of a business combination.

Question 54

Q

Which one of the following, incurred by an acquiring entity in carrying out a business combination, would not be included in the cost of an acquired entity?

Answer

A

Cost of legal fees to carry out the combination

Cost of legal fees (and other direct costs) to carry out the combination would not be included in the cost of an acquired business but would be expensed in the period incurred.

Question 55

Q

A business combination is accounted for using the acquisition method. Which of the following should be deducted in determining the combined corporation’s net income for the current period?
Direct Costs Of Acquisition
General Expenses Related to Acquisition

Answer

A

Direct Costs Of Acquisition - Yes
General Expenses Related to Acquisition - Yes

Acquisition-related costs incurred to carry out a business combination, including both direct costs of acquisition (e.g., finders’ fees; legal, accounting, and consulting fees; etc.) and general expenses related to an acquisition (e.g., cost of acquisition department), are expensed when incurred and enter into the determination of income for the period.

Question 56

Q

Bale Co. incurred $100,000 of acquisition costs related to the purchase of the net assets of Dixon Co. The $100,000 should be

Answer

A

Expensed as incurred in the current period.

This question implies that the acquisition is a business combination. The costs associated with a business combination are expensed as incurred.

Question 57

Q

Describe the requirements of the
acquisition when a business
combination is carried out in stages (or
steps).

Answer

A

Equity interest in the acquiree that is
acquired by the acquirer prior to the
business combination is remeasured to
fair value at the date of the
combination (acquisition date). Any
difference between the
precombination carrying value and the
acquisition date fair value is recognized
as a gain or loss in income of the period
of the combination. The fair value of
the precombination investment is
included as part of the cost of the
investment value (i.e., cost of the
investment in the acquiree) to the
acquirer.

Question 58

Q

Identify at least three items acquired in
a business combination for which the
acquirer has to make a decision as to
the classification or designation of the
item.

Answer

A

Debt investments, as to whether
held to maturity, held for trading,
or available for sale
Derivative instruments, as to
whether used for hedging or
speculation
Embedded derivatives, as to
whether they will be separated
from the host instrument or not
Long-term assets, as to whether
they will be used or held for sale

Question 59

Q

Identify the general acquiree-related
elements that must be recognized and
measured by the acquirer in a business
combination.

Answer

A

Identifiable assets acquired

Liabilities assumed

Noncontrolling interest, if any

Question 60

Q

Identify at least five items acquired in a
business combination that would be
measured at something other than fair
value.

Answer

A

Income tax items: Use
Accounting Standards
Codification (ASC) No. 740 and
other guidelines.
Acquiree’s employee benefit
liability/asset: Use various
related generally accepted
accounting principles.
Indemnification assets: Use the
same measurement basis as for
indemnified items.
Reacquisition rights: Use
unamortized balance.
Share-based employee awards:
Use ASC No. 718.
Long-term assets held for sale:
Use ASC No. 360.

Question 61

Q

On December 31, Year 1, Andover Co. acquired Barrelman, Inc. Before the acquisition, a product lawsuit seeking $10 million in damages was filed against Barrelman. As of the acquisition date, Andover believed that it was probable that a liability existed and that the fair value of the liability was $5 million. What amount should Andover record as a liability as of December 31, Year 1?

Answer

A

$5,000,000

A noncontractual liability that is more likely than not (greater than 50%) to meet the definition of a liability, should be recorded at acquisition date fair value. This lawsuit is probable to occur and should be recorded as part of the business combination at $5 million.

Question 62

Q

Which of the following kinds of intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity?
Future benefits that derive from legal rights
Future benefits that can be separately sold

Answer

A

Future benefits that derive from legal rights - Yes
Future benefits that can be separately sold - Yes

Intangible assets on the books of an acquired entity immediately before a business combination would be recognized by the acquiring entity if they either have future benefits that arise from contractual or legal rights (e.g., trademarks, copyrights, franchise agreements, etc.) or are capable of being separately sold, transferred, licensed, rented, or exchanged (e.g., customer lists, databases, etc.).

Question 63

Q

On July 1, 2009, Lazer, Inc. acquired all of the assets, with a fair value of $400,000, and liabilities, with a fair value of $150,000, of Tipco, Inc. for $250,000 cash. In addition, Lazer paid $20,000 in legal and accounting fees for the combination and expects to pay $50,000 to close one of Tipco’s plants and relocate its employees. Which one of the following is the amount of liability that Lazer should recognize in recording the business combination?

Answer

A

$150,000

Lazer will recognize $150,000 in liabilities, the fair value of the amount acquired from Tipco. The $20,000 legal and accounting fees will be expensed as cost of carrying out the combination. The expected cost of closing one of Tipco’s plants and relocating its employees will not be recognized until there is an actual liability.

Question 64

Q

Which one of the following payments by an acquirer in a business combination is most likely to be a part of the cost in recording a business combination transaction?

Answer

A

Payment by the acquirer to the acquiree for a valid patent not previously recognized by the acquiree

Payment for a valid patent, even though not previously recognized by the acquiree, most likely would be a part of the business combination transaction. Since costs of developing a patentable item are expensed when incurred, the acquiree may not have recognized any asset associated with the patent, but the acquirer should record the patent acquired in a business combination at fair value.

Answer 65

A

A lease classified as a sales-type capital lease by the acquiree

In a business combination, an acquirer that obtains a lease contract should continue to classify the contract as established at the inception of the contract. The classification of a lease contract is established at the inception of the lease and would not change as a result of a transfer of ownership in a business combination.

Answer 66

A

Identifiable Assets Acquired -YES
Liabilities Assumed - YES
Noncontrolling Interest - YES

Generally, identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree are measured at fair value. A few exceptions exist for selected assets and liabilities.

Answer 67

A

I only.

Item I would be recognized; Item II would not be recognized. Contractual contingencies (contingencies related to existing contracts) are recognized by the acquirer and measured at fair value. Noncontractual contingencies (contingencies that do not result from an existing contract), including lawsuits, are recognized only if it is more likely than not that the contingency will give rise to a liability (or an asset). A probability of 20% that the suit will be lost is not more likely than not, and the lawsuit would not be recognized.

Answer 68

A

Fair value, May 1, 2009

When a business combination is accomplished in stages (or steps), the fair value of the investment on the date of the combination is used to value the business combination. In this case, that would be the fair value on May 1, 2009. Any difference between the carrying value and the fair value on the acquisition date would be recognized as a gain or loss for the period.

Answer 69

A

$2,250,000

The $450,000 fair value of the original investment plus the $1,800,000 of cash paid is the total fair value of Lowco.

Answer 70

A

Neither I nor II.

Neither Statement I nor Statement II is correct. The value assigned to a noncontrolling interest in an acquiree would not be based simply on the proportional share of that interest in the net assets of the acquiree (Statement I), but rather on the separately determined fair value of the noncontrolling interest. The fair value per share of the noncontrolling interest in an acquiree does not have to be the same as the fair value per share of the controlling interest (Statement II), because there is likely to be a premium in value associated with having control of an entity that the noncontrolling interest would not enjoy.

Answer 71

A

The fair value of the total investment in
the acquiree (including the acquirer's
consideration transferred and the
noncontrolling interest in the acquiree)
and the fair value of the net assets
(Assets – Liabilities) of the acquiree

Answer 72

A

A bargain purchase is recognized when
the fair value of the total investment in
an acquiree (both the investment of the
acquirer and that of any noncontrolling
interest) is less than the fair value of
the acquiree's net assets.

Answer 73

A

Goodwill is recognized when the fair
value of the total investment in an
acquiree (both the investment of the
acquirer and that of any noncontrolling
interest) is greater than the fair value of
the acquiree's net assets.

Answer 74

A

$190,000

The total cost (consideration transferred) of acquiring Trace should be the cash paid plus the fair value of the stock issued. The cost of carrying out the combination ($12,000) should be expensed. Therefore, the cost would be $100,000 + (5,000 share × $18 market price = $90,000), or $100,000 + $90,000 = $190,000.

Answer 75

A

$220,000

Stock issued in a business combination should be measured at fair value. In some cases in which equities are exchanged, the fair value of the acquiree’s stock may be a more reliable measure of the value of the transaction than can be determined for the acquirer’s stock. In this question, that is the case. Since Dill’s stock is closely held and seldom traded, it is less likely to be the basis for determining fair value than is Ledo’s stock, which is traded in an active market. Therefore, the most likely value for the transaction would be the 20,000 shares of Ledo’s stock that were obtained multiplied by the $11 market price of those shares, or 20,000 shares × $11 = $220,000.

Answer 76

A

Investment Value > Fair Value of Net Assets - No
Investment Value < Fair Value of Net Assets - Yes

A gain can occur in a business combination only when the investment value in the acquired entity is less than the fair value of the entity’s net assets, and not when the investment value is greater than the fair value of those net assets. Thus, when the fair value of the investment by the acquirer and any noncontrolling interest in the acquiree is less than the fair value of the net assets of the acquiree, a bargain purchase gain will be recognized.

Answer 77

A

$180,000

The correct calculation would be the fair value of Trace’s assets $240,000 - the fair value of the liabilities, $60,000 = $180,000.

Answer 78

A

$ - 0 - (no gain)

No gain will be recognized by Windco in connection with its acquisition of Trace. Neither the cash transferred nor the common stock issued had a carrying value less than (or different than) fair value. The carrying value and fair value of the cash are the same, $100,000. And, since the common stock was newly issued, it would be valued at the market price of the stock, with the excess over par value recognized as additional paid-in capital, not as a gain. Further, there was no bargain purchase amount to be recognized as a gain.

Answer 79

A

The fair value of the investment by the acquiring entity and any noncontrolling interest in the acquired entity is greater than the fair value of the acquired entity’s net assets.

Goodwill is based on the excess of investment value over the fair value of net assets. Thus, an acquirer will recognize goodwill only when the fair value of its investment and that of any noncontrolling interest in the acquiree exceeds the fair value of the acquiree’s net assets.

Answer 80

A

Gain.

A gain occurs in a business combination when the investment value in the acquired entity is less than the fair value of the entity’s net assets. Thus, when the fair value of the identifiable net assets acquired exceeds the fair value of the investment by the acquirer and any noncontrolling interest in the acquiree, a bargain purchase gain will be recognized.

Answer 81

A

Goodwill - $ 0
Bargain Purchase Gain - $ $10,000

A bargain purchase gain is the excess of the fair value of the net assets acquired in a business combination over the fair value of the cost of the investment. The cost of investment to Pesto is $350,000, consisting of $200,000 cash and $150,000 fair value of stock issued (10,000 shares × $15 per share). The fair value of Nexto’s net assets is $360,000 ($480,000 assets − $120,000 liabilities). Therefore, the fair value of the net assets exceeds the cost of the investment by $10,000, resulting in a bargain purchase gain.

Answer 82

A

If the contingency is a liability,
measure and report at the higher
of:
1. Its acquisition-date fair
value; or
2. The amount that would be
recognized if the
requirements of
Accounting Standards
Codification (ASC) No. 450
were followed.
If the contingency is an asset,
measure and report at the lower
of:
1. Its acquisition-date fair
value; or
2. The best estimate of its
future settlement amount.

Answer 83

A

If changes are of fair value as it
existed at acquisition date, the
change is an adjustment to the
cost of the investment.

If changes result from events
after the acquisition date:

Changes in contingent
assets or liabilities are
recognized in earnings in
the period of change.
Changes in contingent
equity are an adjustment
to equity accounts, not an
earnings item.

Answer 84

A

Reacquired rights asset

Assets and liabilities arising from
contingencies

Indemnification assets

Contingent consideration as
asset or liability (or equity)

Answer 85

A

A reacquired right asset

A reacquired right is a right granted by an acquirer to the acquiree prior to a business combination that is reacquired when the acquirer gains control of the acquiree or the asset in a business combination. For example, the acquiree may have acquired the right to use the acquirer’s trade name as part of a franchise agreement. A reacquired right is an intangible asset that is amortized by the acquirer over the remaining contractual period of the contract that grants the right.

Answer 86

A

Contingency-based assets

Assets (and liabilities) arising from contingencies are likely to be accounted for using specific post-combination accounting requirements. Those requirements provide that when new information is obtained about a contingency-based asset, it will be measured at the lower of (1) its acquisition-date fair value or (2) the best estimate of its future settlement amount.

Answer 87

A

$19,000 gain

A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 − $9,000 = $19,000).

Answer 88

A

$ - 0 - (no increase or decrease)

A contingent consideration liability is the obligation of an acquirer to transfer additional consideration, if specific conditions are met. Contingent consideration liabilities are initially recognized at fair value and adjusted to fair value each period until the contingency is resolved or expires. A change in fair value resulting from occurrences after the acquisition date would be recognized as a gain or loss in income in the period of the change, not as an adjustment to the consideration paid to acquire the acquiree. In this question, a $19,000 gain (reduction in liability) would be recognized ($28,000 − $9,000 = $19,000) and no change in the consideration paid will be recognized.

Answer 89

A

As a gain in earnings at the acquisition date

A bargain purchase means that the acquirer paid less than the fair market value of the identifiable net assets. The seller must have been under some sort of duress (perhaps eminent bankruptcy) and was willing to accept a price less than the value of the net assets. In this case the acquirer recognizes that gain on the date of the acquisition.

Answer 90

A

Capitalize the cost of refurbishing and record a loss in the current period equal to the carrying amount of the damaged portion of the building.

When the portion of an asset is damaged, and that portion has identifiable costs and accumulated depreciation, the identifiable amounts associated with the damage are removed from the general ledger. The difference between the cost and accumulated depreciation is the carrying value of the damaged portion of the larger asset. In this problem there was no insurance proceeds. Therefore, the carrying value of the damaged portion of the asset is written off as a loss and the replacement of that asset is capitalized. The entries would be:

Portion removed
DR:	Loss
DR:	Accumulated Depreciation
CR:	Asset
Cost of replacement
DR:	Asset
CR:	Cash

Answer 91

A

Name and description of the
acquired business
The acquisition date
The percentage voting interest
acquired (if relevant)
How the acquirer gained control
of the acquired business
The primary reason for the
business combination

Answer 92

A

In the reporting period in which the
combination occurs and in each
reporting period that includes the
measurement period

Answer 93

A

A quantitative description of the
factors that make up the
goodwill
The amount of goodwill expected
to be deductible for tax purposes
The amount of goodwill assigned
to each reportable segment
During the measurement period,
a reconciliation of the beginning
and ending balance in goodwill

Answer 94

A

Identification of the items
(assets, liabilities, equity, or
consideration) for which
accounting is not complete

The reasons why the accounting
is not finalized

The nature and amounts of any
measurement-period
adjustments made to the
provisional amounts during the
reporting period

Answer 95

A

I, II, and III.

Statements I, II, and III are all required. When goodwill is recognized in a business combination, a quantitative description of the factors that make up the goodwill (Statement I), the amount of goodwill that is expected to be deductible for tax purposes (Statement II), and the amount of goodwill allocated to each reportable segment (Statement III) must all be disclosed.

Answer 96

A

Both I and II.

Both Statements I and II identify circumstances that require extensive disclosures in the period of a combination. When there is a noncontrolling interest in the acquiree, the fair value of the noncontrolling interest at the acquisition date, and the valuation techniques and inputs used to measure that fair value, must be disclosed. When control is achieved in steps (or stages), the fair value of the equity held by the acquirer immediately before the combination, the amount of any gain or loss resulting from adjusting the interest to fair value, and the line item in the income statement where the gain or loss is reported must be disclosed.

Answer 97

A

I, II, and III.

All three statements identify required disclosures. When a bargain purchase occurs in a business combination, the amount of the gain (Statement I), the income statement line item that includes the gain (Statement II), and a description of the basis for the bargain purchase amount (Statement III) must be disclosed.

Answer 98

A

I and II only.

Statements I and II are correct. Statement III is not correct. If provisional amounts are reported for items recognized in a business combination, the reasons why the accounting is incomplete (i.e., the amounts are provisional) (Statement I) and the amounts of adjustment(s) made to the provisional amounts during the period (Statement II) - as well as the specific items for which the amounts are provisional - must be disclosed. The date at which each provisional amount is expected to be resolved is not a required disclosure (Statement III).

Answer 99

A

During the Reporting Period - Yes
After the Reporting Period but Before Statements are Released - Yes

Financial statement disclosures that enable users to evaluate the nature and financial effects of a business combination must be made both when the combination occurs during the reporting period and when the combination occurs after the reporting period but before the financial statements are released.

Answer 100

A

I, II, and III.

Statements I, II, and III are all required disclosures. The primary reason for a business combination (Statement I), how the acquirer gained control of the business (Statement II), and the acquisition date fair value of consideration transferred and each major class of asset acquired and liability assumed (Statement III) must all be disclosed.

Answer 101

A

Bargain purchase.

Answer 102

A

Reported in consolidated statements,
unless the parent lacks effective
control

Answer 103

A

DR: Assets acquired (at fair value)
CR: Liabilities assumed (at fair value)
CR: Cash/Other Consideration Paid
(Cost)

Answer 104

A

Acquisition method

Answer 105

A

Cost, equity or fair value method

Answer 106

A

DR: Investment in Subsidiary

CR: Cash/Other Consideration (Cost)

Answer 107

A

$-0-

As a newly formed entity, Seashell will have no retained earnings until after an operating period. Seashell’s shareholders’ equity immediately following the consolidation will consist of the common stock issued (at par), $250,000, and additional paid-in capital, $245,000. Immediately after the consolidation, there will be no retained earnings.

Answer 108

A

$1,365,000

The calculation is:

Fair value (200,000 sh. × $12/sh.) $2,400,000
Par value (200,000 sh. × $5/sh) (1,000,000)
Gross additional paid-in capital $1,400,000
Less: Registration and issuance costs 35,000
Net additional paid-in capital $1,365,000

The legal and consulting fees ($110,000) were paid in cash and would be expensed in the period incurred. The registration and issuance costs of the common stock are properly deducted from the additional paid-in capital derived from the issuance of the stock.

Acquisition-related costs (expect as noted below) should be expensed in the period in which the costs were incurred and the services are received. These costs, in this case the $110,000 legal and consulting fees incurred in relation to the acquisition, are not included as part of the cost of an aquired business.

The cost of issuing debt and equity securities for the purposes of a business combination are not treated as cost of the acquired business, but should be accounted for generally as follows:

Debt issuance costs may be either recognized as a deferred asset and amortized over the life of the debt, or expensed when incurred. In this case, equity was issued in the acquisition, not debt.
Equity issuance costs reduce the proceeds from the securities issued and, in effect, reduce Additional Paid-in Capital. In this case, the information states $35,000 is incurred for registration and issuance costs for the stock issued.

Answer 109

A

Debit: Goodwill

The entry that Plant will make to record its legal acquisition of Seed cannot include a debit to Goodwill. The entry Plant makes will debit (only) the Investment account and credit whatever form(s) of consideration is given (e.g., Cash, Bonds Payable, Common Stock, etc.). Goodwill cannot be debited at the time of the acquisition, though it may be recognized at the time of consolidation.

Answer 110

A

$-0-

Since Seashell’s stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell’s stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the consideration given (common stock issued) is equal to the fair value of net assets acquired, and no goodwill is recognized.

Answer 111

A

$3,600,000

The cost of acquiring a company includes all cash and other assets distributed, liabilities incurred, and equity shares issued, all at fair value. Direct costs of carrying out a combination (such as accounting, legal, consulting, and finders’ fees) are expensed in the period incurred; they are not included as part of the acquired entity. The cost of registering and issuing securities used to effect a business combination are charged against the fair value of the securities issued and, for equity securities, serve to reduce the amount of additional paid-in capital recognized. Thus, this correct answer ($3,600,000) was computed as 100,000 shares issued × $36 per share (fair market value) = $3,600,000. The $160,000 fees paid to a consultant would have been expensed, and the $80,000 cost of registering and issuing the common stock would have reduced the amount recognized from the sale of the stock.

Answer 112

A

Investment in Straw.

Pine will not recognize on its books an investment in Straw. Because the business combination is a legal merger, Pine recognizes on its books almost all of Straw’s assets and liabilities, not an investment in Straw. There can be no investment in Straw, because Straw will cease to exist.

Answer 113

A

$245,000

Since Seashell’s stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell’s stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the fair value of the stock issued is equal to the fair value (and book value) of the net assets acquired (i.e., A − L = SE), or $495,000. The par value of the stock issued is $250,000 (25,000 × $10). Therefore, additional paid-in capital is $495,000 − $250,000 = $245,000.

Answer 114

A

$160,000

Goodwill is measured as the amount by which the cost of an investment in an entity exceeds the fair value of the net assets acquired. In this question, the cost of the investment is $860,000, and the fair value of net assets acquired is $700,000 ($840,000 − $700,000), resulting in goodwill of $160,000.

Answer 115

A

Fair value of net assets acquired < Cost of investment

Goodwill is recognized when the cost of the investment is greater than the fair value of net assets acquired (= the fair value of net assets acquired is less than the cost of the investment). In a legal merger, the goodwill would be recognized on the books of the surviving firm at the time of the business combination.

Answer 116

A

Contingent assets are recognized only

under U.S. GAAP.

Answer 117

A

Cash-generating units

Answer 118

A

Yes, you are required to disclose these

assumptions.

Answer 119

A

When it is acquired in a business combination.

The requirement is to identify the statement that correctly describes how goodwill may be recognized under IFRS. Goodwill can be recognized only if it is acquired in a business combination.

Answer 120

A

Fair value at the acquisition date.

An intangible asset that is acquired in a business combination is initially measured at acquisition date fair value.

Answer 121

A

Contingent asset

Under IFRS, contingent assets are not recognized. Under U.S. GAAP, contingent assets are recognized if the item meets the criteria of the definition of an asset.

Answer 122

A

Accounts payable
Notes and bonds payable
Option contracts (with
unfavorable terms)
Futures and forward contracts
(with unfavorable terms)
Swap contracts (with
unfavorable terms)

Answer 123

A

Cash
Evidence of an ownership
interest in an entity
Contracts that result in an
exchange of cash or ownership
interest in an entity that:
Imposes on one entity a
contractual obligation
(liability) and
Conveys to a second entity
a contractual right (asset)

Answer 124

A

Cash and cash equivalents
Accounts receivable
Investments in debt or equity
securities
Ownership interest in a
partnership, joint venture, or
other entity
Option contracts (with favorable
terms)
Futures and forward contracts
(with favorable terms)
Swap contracts (with favorable
terms)

Answer 125

A

Speculative.

When derivatives are used for speculative purposes, the intent is not to hedge an existing position, because there is no existing position to hedge. Rather, when used for speculative purposes, the intent is to make a profit.

Answer 126

A

Investments in Debt Securities - Yes
Investments in Equity Securities - Yes
Bonds Payable - Yes

Answer 127

A

All financial instruments have the same accounting requirements.

All financial instruments do not have the same accounting requirements. Because financial instruments cover a variety of assets and liabilities, and are used for different purposes, there are different accounting requirements for different financial instruments, including derivatives.

Financial instruments do include derivatives instruments. Derivatives are a special form of financial instrument with unique characteristics. Not all financial instruments are derivatives, but all derivatives are financial instruments.

Certain disclosure requirements do apply to all financial instruments. Specific disclosure requirements include the fair value of the instrument, whether the instrument is an asset or liability, and any concentrations of credit risks associated with the instruments.

Financial instruments, and especially derivative financial instruments, can be used for hedging purposes.

Answer 128

A

All derivative instruments have the same accounting requirements.

All derivative instruments do not have the same accounting requirements. The appropriate accounting requirements depend on the specific purpose of holding or issuing the derivative instrument.

Derivative instruments are a form of financial instrument. Derivatives are a special form of financial instrument with unique characteristics. All financial instruments are not derivatives, but all derivatives are financial instruments.

Derivative instruments can be used for hedging purposes. When used for hedging purposes, the intent is that the derivative instrument will provide an outcome that is the opposite of the item being hedged. For example, if the hedged item incurs a loss, the hedging instrument (derivative) would be expected to incur a gain.

Derivative instruments can be used to hedge foreign currency risk. Foreign currency risk derives from the possible loss resulting from adverse changes in the exchange rate between currencies. When used for foreign currency hedging purposes, the intent is that the derivative instrument will provide an outcome that is the opposite of the foreign currency being hedged. For example, if the change in exchange rate would result in a loss on the item hedged, the change in exchange rate would be expected to result in a gain on the hedging instrument (derivative).

Answer 129

A

Under IFRS, an impairment loss is
determined as the difference between
the carrying amount of the asset and its
recoverable amount. The amount of
any impairment loss is recognized in
current income.

Answer 130

A

Financial assets measured at fair
value with changes reported
through profit/loss
Loans and receivables
Instruments held to maturity
(other than loans and
receivables)
Instruments available for sale

Answer 131

A

Financial assets classified as "loans
and receivables" under IFRS are
measured at amortized cost, with
related interest and amortization
recognized in current income.

Answer 132

A

Financial liabilities measured at
fair value with changes reported
through profit/loss, including:

Liabilities held for trading.

Derivatives (that are
liabilities).

Financial liabilities for
which the fair value option
is elected.

Other liabilities

Answer 133

A

Redeemable preferred stock.

Under IFRS, redeemable preferred stock would likely be treated in its entirety as a financial liability because the stock can be redeemed (repurchased) by the issuing corporation at its discretion. Since the preferred shares can be redeemed at the discretion of the issuing corporation, it is not treated as equity, but rather as a liability.

Under IFRS, common stock with a preemptive right would not be treated as a financial liability. Common stock that contains a preemptive right grants the holder of the stock the right to acquire a proportionate share of newly issued common stock. Common stock with a preemptive right has no characteristics of debt and would not be treated as a financial liability under IFRS. Redeemable preferred stock is most likely to be treated in its entirety as a financial asset.

Under IFRS, convertible preferred stock is not likely to be treated in its entirety as a financial liability, but will be treated in its entirety as equity. Convertible preferred stock, which is convertible to common stock, has no characteristics of debt and would not be treated as a financial liability under IFRS (or under U.S. GAAP). Redeemable preferred stock is most likely to be treated in its entirety as a financial asset.

Under IFRS, convertible debt is not likely to be treated in its entirety as a financial liability, but is likely to be treated as both a financial liability, for the value of the debt element, and equity, for the value of the convertible feature. Redeemable preferred stock is most likely to be treated in its entirety as a financial asset.

Answer 134

A

Related assets and liabilities are valued using different measures.

An “accounting mismatch” refers to a circumstance where related assets and liabilities are valued using different measures.

As used in IFRS, an “accounting mismatch” does not describe a circumstance where the value of a hedging instrument does not equal the value of the hedged item.

As used in IFRS, an “accounting mismatch” does not describe a circumstance where liabilities exceed assets.

As used in IFRS, an “accounting mismatch” does not describe a circumstance where debts don’t equal credits.

Answer 135

A

Amortized cost, with interest and amortization recognized in current income.

Financial assets classified as “Loans and Receivables” are measured at amortized cost, with interest and amortization related to the instrument recognized in current income. This treatment is the same as the treatment under U.S. GAAP for investments held to maturity.

Answer 136

A

Information about the common
activity, region, or economic
characteristic that identifies the
concentration

The maximum (gross) amount of
loss due to the credit risk
The entity's policy of requiring
collateral or other security to
support financial instruments
subject to credit risk

The entity's policy of entering
into master netting
arrangements to reduce the
credit risk associated with
financial instruments

Answer 137

A

Market risk is the possibility of loss
from changes in market values due to
changes in economic circumstances,
not necessarily due to the failure of
another party to perform.

Answer 138

A

Fair value

Related carrying amount

Whether the instrument/amount
is an asset or liability

Answer 139

A

The reasons why it is not
practicable to estimate fair value
Information pertinent to
estimating fair value, such as
carrying amount, effective
interest rate, maturity date, and
so on

Answer 140

A

Credit risk is the possibility of loss from
the failure of another party (or parties)
to perform according to the terms of a
contract.

Answer 141

A

All financial instruments.

All entities must disclose all significant concentrations of credit risk arising from all financial instruments, whether from a single entity or a group of parties that engage in similar activities and that have similar economic characteristics.

Disclosure of information about significant concentrations of credit risk is not limited to financial instruments with off-balance-sheet risk of accounting loss, but must be provided for all financial instruments. Risk of accounting loss refers to the possibility of a loss being recognized for accounting purposes as a result of changes in market risk, credit risk, or other risk associated with financial instruments.

Answer 142

A

Financial Statements
Footnotes to - Yes

Financial Statements - Yes

Fair value disclosure of financial instruments may be made in either the body of the financial statements or in the footnotes to the financial statements. If in the footnotes, one note must show fair values and carrying amounts for all financial instruments.

Answer 143

A

Maximum amount at risk.

When a concentration of credit risk exists, the maximum amount at risk must be disclosed. The maximum amount is measured as the gross fair value of all financial instruments that would be lost if the other parties fail completely to perform according to the terms of the contract(s) and assuming any collateral was of no value.

Answer 144

A

Both I and II.

When it is not practicable for an entity to estimate the fair value of a financial instrument, both information pertinent to estimating the fair value of the instrument and the reasons it is not practicable to estimate fair value must be provided.

Answer 145

A

An embedded derivative is a portion of,
or term in, a contract (host contract
that is not itself a derivative) that
behaves like a derivative.

Answer 146

A

A specified price, rate, or other variable
(e.g., a stock price, interest rate,
currency exchange rate, etc.)

Answer 147

A

Hedging is a risk management strategy
that involves using offsetting (or
counter) transactions or positions.

Answer 148

A

1. One or more underlying and one
or more notional amounts
2. Requires no initial net
investment
3. Terms require or permit a net
settlement.

Answer 149

A

By multiplication (or other calculation)
of the notional amount and the
underlying

Answer 150

A

A specified unit of measure (e.g.,
number of shares of stock, pounds or
bushels of a commodity, number of
foreign currency units, etc.)

Answer 151

A

A contract that has its settlement value tied to an underlying notional amount.

A contract that has its settlement value tied to an underlying notional amount best describes a derivative financial instrument. The value or settlement amount of a derivative is the amount determined by the multiplication (or other arithmetical calculation) of a notional amount and an underlying. Simply put, a derivative instrument is a special class of financial instrument which derives its value from the value of some other financial instrument or variable.

Answer 152

A

No possibility of future gain or loss.

Hedging is a risk management strategy which involves making an investment (the hedge) so as to offset (or counter) another investment (the hedged item) so that a loss on one investment (the hedged item) would be offset (at least in part) by a gain on the other investment (the hedge), and vice versa. A perfect hedge is achieved when the hedge investment has a 100% inverse correlation to the initial investment (hedged item) so that there is no possibility of future gain or loss. A perfect hedge rarely exists.

Answer 153

A

$50.00 per option.

Stock options are derivatives; they derive their value from the value of the stock to which the option applies. The underlying of a derivative is a specified price, rate, or other monetary variable, in this case the (strike) price of each option, $50.00.

Answer 154

A

$100

The intrinsic value of a call option is the difference between the exercise (strike) price and the market price. This call option has an exercise price of $9 / share and the market price is $10 / share. Therefore, there is a $1 / share intrinsic value (I can buy the stock at a price less than the market). The option is to purchase 100 shares so the total intrinsic value is $100.

Answer 155

A

A derivative requires contractual satisfaction by delivery of the subject matter of the contract.

A derivative does not require contractual satisfaction by delivery of the subject matter of the contract. Specifically, the terms of a derivative require or permit the contract to be settled with cash or an asset readily convertible to cash, in lieu of physical delivery of the subject matter of the contract. In addition, a derivative includes an underlying, a notional amount, and requires no initial net investment or one that is less than normally would be required.

A derivative does identify a specific quantity or other quantitative unit of measure, called a “notional amount.” In addition, a derivative includes an underlying, requires no initial net investment or one that is less than normally would be required, and has terms that require or permit a net settlement.

A derivative does identify a specific price, rate, or other monetary measured, called an “underlying.” In addition, a derivative includes a notional amount, requires no initial net investment or one that is less than normally would be required, and has terms that require or permit a net settlement.

A derivative is a financial instrument (or similar contract) with specific characteristics, including an underlying, a notional amount, no initial net investment or one that is less than normally would be required, and terms that require or permit a net settlement.

Answer 156

A

Derivatives not used as a hedge
Fair value hedges
Cash flow hedges
Foreign currency hedges

Answer 157

A

Fair Value - Yes
Cash Flows - Yes

The risks associated with a foreign currency that can be hedged can be either the risk to fair value in the foreign currency or the risk to cash flows in the foreign currency.

Answer 158

A

Neither I nor II.

Neither Statement I nor Statement II is correct. Derivative instruments can be used not only for hedging purposes (Statement I), but also for speculative purposes. In addition, derivative instruments can be used not only to hedge fair value (Statement II), but also to hedge cash flows.

Answer 159

A

Fair Value - Yes
Cash Flows - Yes

The two basic kinds of risks that can be hedged for accounting purposes are fair value risks and cash flow risks.

Answer 160

A

Fair value of an investment accounted for using the equity method of accounting.

The fair value of an investment accounted for using the equity method of accounting is specifically excluded as being eligible to be hedged for accounting purposes under U.S. GAAP.

The foreign currency risk associated with a net investment in a foreign operation (e.g., an investment in a foreign subsidiary) can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes.

The credit risk of investments classified as held for trading can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes.

The overall change in the fair value of a non-financial asset (e.g., inventory) can be hedged for accounting purposes. The fair value of an investment accounted for using the equity method of accounting cannot be hedged for accounting purposes.

Answer 161

A

The hedge of exposure to changes in
fair value of a recognized asset,
recognized liability, or an unrecognized
firm commitment from a particular risk

Answer 162

A

When an entity enters into a contract to
buy or sell but has not yet booked the
transaction

Answer 163

A

Adjusting the carrying amount of
the derivative and hedged item
to fair value
Recognizing gains/losses from
revaluing the derivative and the
hedged item in current income

Answer 164

A

The hedging relationship

The objective and strategy for
undertaking the hedge

Identification of the hedging
instrument and hedged item

Nature of the risk being hedged

How effectiveness of the hedge
will be assessed

Answer 165

A

$20

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 2009 offsets the change in the fair value of the raw materials. Specifically, the decrease in the value of the raw materials, $200 ($19,500 − $19,300 = $200), was offset by the increase in the value of the forward contract of $220 ($700 − $480 = $220), so the net gain recognized in 2009 was $220 − $200 = $20, which is the correct answer.

Answer 166

A

$20

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 offsets the change in the fair value of the raw materials. Since during 2008 the change in the value of the raw materials decreased more than the value of the forward contract increased, the difference is the amount by which the derivative is ineffective as a fair value hedge. 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 hedge was ineffective by $500 − $480 = $20, which is the correct answer.

Answer 167

A

It has been recorded as an asset or liability.

A firm commitment has not been recorded (yet) as an asset or liability. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged.

The subject matter of a firm commitment is at risk of change in fair value. A firm commitment occurs when an entity has a contractual obligation or contractual right, but no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met. Nevertheless, the subject matter of the firm commitment is at risk of change in fair value and can be hedged.

firm commitment is evidenced by a contractual obligation (or contractual right) - that is the nature of the “firm” part of the commitment. Despite the firm nature of the contract (or commitment), no transaction has been recorded (and no asset or liability recognized) because GAAP requirements for recognition have not yet been met.

Answer 168

A

$20

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.

Answer 169

A

The hedge of an exposure to variability
(changes) in the cash flow associated
with a (recognized) asset, liability, or a
forecasted transaction due to a
particular risk.

Answer 170

A

A forecasted transaction is a planned or
expected transaction for which there is
not yet either a firm commitment or
any rights or obligations established.

Answer 171

A

The forecasted transaction is:
Specifically identified as a single
transaction or group of individual
transactions with the same risk
exposure;
Probable of occurring;
With an external party (with
limited exceptions);
Capable of affecting cash flows
and earnings; and
Not for acquisition of an asset or
incurrence of a liability
accounted for at fair value with
the change reported in current
income.

Answer 172

A

Each period the change in fair value of
the derivatives is used to:
Adjust the derivative instrument
to fair value.
Recognize the change in value in
other comprehensive income.

Answer 173

A

The present value of expected cash inflows or outflows.

The item being hedged in a cash flow hedge is measured using the present value of expected cash inflows or cash outflows. The item being hedged in a cash flow hedge may be associated with an asset, a liability, or a forecasted transaction. The value of such items is measured using the present value of either cash inflows (e.g., receivable) or cash outflows (e.g., payable), depending on the nature of the item being hedged.

Answer 174

A

Can be a hedged item in a cash flow hedge.

A forecasted transaction can be the hedged item in a cash flow hedge. A forecasted transaction is a planned or expected transaction which has not yet been recognized, but which is subject to the risk of changes in related cash flow. As such, the cash flow (inflow or outflow) associated with forecasted transactions can be hedged.

Answer 175

A

Asset - Yes
Forecasted Transaction - Yes

Derivative instruments may be used to hedge the cash flows associated with assets, liabilities, or forecasted transactions.

Derivative instruments may be used not only to hedge the cash flows associated with forecasted transactions, but also with assets and liabilities.

Answer 176

A

The hedge of an exposure to changes in
the dollar value of assets or liabilities
(including certain investments) and
planned transactions that are
denominated (to be settled) in a
foreign currency

Answer 177

A

1. Forecasted foreign currency–
denominated transactions
2. Unrecognized foreign currency–
denominated firm commitments
3. Foreign currency–denominated
recognized assets or liabilities
4. Investments in AFS securities
5. Net investments in foreign
operations

Answer 178

A

Are all treated as fair value hedges.

All foreign currency hedges are not treated as fair value hedges. While foreign currency hedges of unrecognized firm commitments, investments in available-for-sale securities, and net investments in foreign operations are treated as fair value hedges, foreign currency hedges of forecasted transactions are treated as cash flow hedges, and foreign currency hedges of recognized assets or liabilities may be treated either as fair value hedges or cash flow hedges, depending on management’s designation.

Answer 179

A

I, II, and III.

Foreign currency hedges can be used to hedge the risk of exchange rate changes on planned (forecasted) transactions, available-for-sale investments, and accounts receivable/accounts payable (and unrecognized firm commitments and net investments in foreign operations).

Answer 180

A

Recognized liability.

A foreign currency hedge of a recognized liability hedges the risk of exchange rate changes on the cash flow (or fair value) of a liability between the time it is recorded (recognized) and the time it is settled in a foreign currency.

Answer 181

A

Fair Value - Yes
Cash Flow - Yes

Foreign currency hedges may be either fair value or cash flow hedges. Foreign currency hedges of unrecognized firm commitments, investments in available-for-sale securities, and net investments in foreign operations are fair value hedges. Foreign currency hedges of forecasted transactions are cash flow hedges. Additionally, foreign currency hedges of recognized assets or liabilities may be treated either as fair value hedges or cash flow hedges, depending on management’s designation.

Answer 182

A

Net gain/loss recognized in
earnings and where net gain/loss
is reported in the financial
statements

Net gain/loss recognized in
earnings from hedged firm
commitments that no longer
qualify for hedge treatment

Answer 183

A

Fair value hedges, cash flow hedges,
hedges of investments in foreign
operations, and other derivatives

Answer 184

A

Issue Derivatives - Yes
Hold Derivatives - Yes

Entities that either issue or hold derivatives (or other contracts used for hedging) must disclose a considerable amount of information concerning their reasons for using derivatives and the outcomes (e.g., gains/losses) of their accounting for the derivatives. Generally, these disclosures must distinguish between instruments used for different purposes (e.g., fair value hedges, cash flow hedges, etc.).

Answer 185

A

The amount of gain or loss arising during the period that was deferred.

When derivatives are used for fair value hedges, the amount of gain or loss arising during the period that was deferred does not exist (and therefore is not required). When fair value hedges are used, any resulting gain or loss is recognized in current income, not deferred.

Answer 186

A

II only.

When derivatives are used as cash flow hedges, an amount of gain or loss can be deferred in other comprehensive income and subsequently become part of accumulated other comprehensive income. Amounts of accumulated other comprehensive income (on the hedging instrument) will be reclassified to income when the hedged item affects income.

Answer 187

A

I and II only.

Both the net gain or loss recognized in earnings during the period (Statement I) and the amount of gain or loss deferred in other comprehensive income (Statement II) must be disclosed. Statement III is not a required disclosure.

Answer 188

A

Notional amount

Answer 189

A

Part-term hedges are allowed.

Answer 190

A

Both I and II.

Both Statement I and Statement II are correct. IFRS permits (1) hedging a forecasted business combination that is subject to foreign exchange risk, and (2) hedging part of the life of a hedged item. U.S. GAAP does not permit hedging in either case.

Answer 191

A

The instrument has a notional amount.

The definition of a derivative under IFRS does not include the concept of notional amount.

The definition of a derivative under IFRS does include the concept of underlying.

The definition of a derivative under IFRS does include the concept of little or no initial net investment.

The definition of a derivative under IFRS does include the concept of net settlement.

Answer 192

A

The currency of the primary economic
environment in which an entity
operates and generates cash flows

Answer 193

A

Transactions of a domestic entity
denominated in a foreign currency but
to be recorded on the domestic entity’s
books in the domestic currency

Answer 194

A

1. Determine the dollar amount to
settle the transaction at balance
sheet date (# of foreign currency
units × Exchange rate/Spot = $
Value).
2. Determine the difference
between recorded amount and
settlement amount.
3. Record the difference as an
adjustment to the foreign
currency–denominated account
and as an exchange gain/loss for
the period.

Answer 195

A

The exchange rate (existing now) for a

specified future date

Answer 196

A

1. Determine the dollar amount to
settle the transaction at balance
sheet date (# of foreign currency
units × Exchange rate/Spot = $
Value).
2. Determine the difference
between the recorded amount
and the settlement amount.
3. Record the difference as an
adjustment to foreign currency–
denominated account and as an
exchange gain/loss for the
period.
4. Record settlement of the foreign
currency–denominated account.

Answer 197

A

The foreign price of one domestic unit

of currency

Answer 198

A

The exchange rate at current date

Answer 199

A

The price of one unit of a country’s
currency expressed in units of another
country’s currency

Answer 200

A

Financial statements denominated in
(expressed in terms of) a foreign
currency but to be reported in the
domestic currency (on financial
statements)

Answer 201

A

1. Translate transaction into dollars
using current spot exchange rate
(# of foreign currency units ×
Exchange rate/Spot = $ Value).
2. Record asset, liability, revenue,
expense, loss and/or gain at
dollar amount.

Answer 202

A

Multiply the number of foreign currency
units specified by the terms of the
transaction by the spot exchange rate
at the current date.

Answer 203

A

A transaction that is denominated (will
be settled) in a foreign currency (i.e.,
other than the recording entity’s
currency)

Answer 204

A

Measure and record the
transaction on books in terms of
the functional currency.
Convert foreign currency units to
functional currency units using
the spot exchange rate.
Recognize the effect of exchange
rate changes as gains/losses in
the period of the exchange rate
change.

Answer 205

A

At balance sheet date, if one
occurs between the date the
transaction is initiated and
settled
At settlement date of the foreign
currency–denominated account
balance

Answer 206

A

$1.32

If $1.00 will buy 0.76 Euro, then 0.76E = $1.00, and E = $1.00/0.76, or E = $1.32. So, one Euro will buy $1.32, the correct answer.

Answer 207

A

Been denominated in U.S. dollars.

If the transaction was denominated in U.S. dollars, there is no foreign exchange gain or loss for Mild. (There would be a gain or loss for Grund.)

Answer 208

A

I. 0.89 JPY per $1.00.

II. $.011 per 1.00 JPY.

II only.

A direct quotation, or direct exchange rate, states the domestic price of one unit of a foreign currency. In this case, each JPY costs $.011, which is a direct quotation.

Answer 209

A

Exchange loss.

Since the foreign currency account payable had a settlement amount greater than its previously recorded carrying amount, Domco would have to recognize the change in settlement amounts in the period in which the settlement amount changed—20X8. Specifically, since the amount to settle the account payable increased during 20X8, Domco would have to recognize an exchange loss - it will take more dollars to acquire the foreign currency needed to settle the account.

Answer 210

A

Gains and losses are deferred until transactions are settled.

Gains and losses on foreign currency operating transactions that result from changes in currency exchange rates are not deferred. Such gains and losses must be recognized in current income of the period in which the currency exchange rate changes.

Answer 211

A

As an item of income from continuing operations.

Foreign currency exchange gains (or losses) on accounts receivable are reported in current income as an item of income from continuing operations.

Answer 212

A

$133,333

If $1.00 will buy 0.75 Euro, then 0.75E = $1.00, and E = $1.00/0.75, or E = $1.33. So, one Euro will cost $1.33; therefore, 100,000 E × $1.33 = $133,333, the correct answer.

Answer 213

A

Of the environment in which the subsidiary primarily generates and expends cash.

By definition (SFAS #52), an entity’s functional currency is the currency of the primary economic environment in which the entity operates. Normally, that is the currency of the environment in which the entity primarily generates and expends cash.

Answer 214

A

$772

Since the exchange rate changed between the date the obligation was incurred (July 1) and the date it was settled (August 29), the effects of the exchange rate change must be recognized as an exchange gain or loss. The correct answer would be the difference between the spot rate on July 1 and the spot rate on August 29, or (500,000B/35.0B per $ = $14,286) - (500,000B/37.0B per $ = $13,514) = $772.

Answer 215

A

A gain of $25,000 in the income statement.

A gain of $25,000 should be reported in the current income statement. The gain was computed as:

November 20
$1.25 × 500,000 British pounds = $625,000

December 31
$1.20 × 500,000 British pounds = $600,000
Gain $ 25,000

And, gains (and losses) on foreign currency transactions should be reported in current income.

Answer 216

A

Be included as a component of income from continuing operations for 20X8.

The foreign currency exchange loss that occurred as a result of the exchange rate change in 20X8 should be recognized in 20X8 as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.

Answer 217

A

Purchase of goods to be paid in a foreign currency.

The purchase of goods by a U.S. entity would most likely reflect an import transaction and, since it is to be settled in a foreign currency, would be a foreign currency import transaction.

Answer 218

A

In the same fiscal period - Yes
In a later fiscal period - Yes

A gain or loss on a foreign currency import transaction can be recognized if the transaction is initiated in one fiscal period and settled in either the same fiscal period or a later fiscal period. The effect of exchange rate changes on accounts denominated in a foreign currency should be recognized in the period(s) in which the exchange rate changes. Therefore, if such an account (e.g., account payable) exists in more than one period, the effects of exchange rate changes in either or both periods would result in the recognition of a gain or loss in either or both periods.

Answer 219

A

Component of income from continuing operations.

The foreign currency exchange gain that occurred as a result of the exchange rate change should be recognized as a component of income from continuing operations in the income statement. Gains and losses resulting from changes in exchange rates are recognized in current earnings in the period in which the exchange rate changes.

Answer 220

A

A settlement amount greater than the recorded amount results in an exchange gain.

Because an import transaction normally results in a liability to the buyer (importer), a settlement amount (of the liability) greater than the current carrying amount of the liability will result in an exchange loss, not an exchange gain.

Answer 221

A

$1,500

When a monetary obligation in a foreign currency exists, all gains and losses reflective of changes in exchange rates are recognized in current income.

The loss would be based on the rate at initiation and the rate at year end. (The recovery in the next period would be treated as a gain in that period.) The loss is $1,500 [($.55 – $.70)10,000], making this response correct.

Answer 222

A

$197,600

At the date Don Co. entered into the transaction, June 19, and agreed to accept euros in satisfaction of its account receivable, it should record the transaction (sale and account receivable) at the (then existing or current) spot exchange rate of .988. Thus, the dollar amount of the account receivable (and sale) would be computed as 200,000 E × .988 = $197,600, which also is the dollar value that would be received if the transaction were settled at that date.

Answer 223

A

Transaction gain reported as a component of income from continuing operations.

The event described is a foreign currency (FC) transaction, not FC translation, and the gain (or loss) would be reported as a component of income from continuing operations for the current period.

Answer 224

A

$4,000

December 31, 20X5 .4675
- January 10, 20X6 .4475
Equals 0.02

0.02 x 200,000 = 4000

Cash or amounts owed by or to a company that are denominated in a foreign currency should be translated at the current rate with a gain or loss being recognized. Recognition is based on the change in the spot rate between the recording of the transaction and the date of the financial statements.

The other critical date is the date at which the transaction became an amount owed by or to the company. This occurs at the transfer of title date of December 10, 20X5. Any change before that date is an adjustment in the cost of the merchandise.

This correctly picks up the gain as the change between when the debt was established and the balance sheet date.

Answer 225

A

$387,000

The correct answer is derived by multiplying the number of Euros to be received (300,000) by the dollar cost (value) per Euro at the date of the sale ($1.29), or 300,000E × $1.29 = $387,000. The amount of the sale would not be adjusted for subsequent changes in exchange rates.

Answer 226

A

$3,000

The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 1, the date of the sale, and December 31, the end of 20X8, and getting the difference. That calculation would be (300,000E × $1.29 = $387,000) – (300,000E × $1.28 = $384,000) = $3,000, the correct answer.

Answer 227

A

Sale of goods to be collected in a foreign currency.

The sale of goods to be collected in a foreign currency would be a foreign currency export transaction. A foreign currency transaction occurs when a U.S. entity enters into a transaction that is denominated (to be settled) in a foreign currency, not in dollars.

Answer 228

A

$3,000

The correct exchange gain or loss would be calculated by multiplying the 300,000 Euros to be received by the spot exchange rates on December 31, the end of 20X8, and January 30, the settlement date, and getting the difference. That calculation would be (300,000E × $1.28 = $384,000) – (300,000E × $1.27 = $381,000) = $3,000, the correct answer.

Answer 229

A

$100

A foreign currency exchange gain will be recognized for the change in exchange rate between December 31 and the January collection date. That gain is computed as $1.45 -> $1.50 = $0.05 × 2,000 pounds = $100 gain.

Answer 230

A

Transaction loss reported as a component of income from continuing operations.

The event described is a foreign currency (FC) transaction, not FC translation, and the loss (or gain) would be reported as a component of income from continuing operations for the current period.

Answer 231

A

$7,500 gain

A foreign exchange gain or loss is recognized for any change in value of a monetary debt denominated in a foreign currency. This is true at balance sheet time as well as when it is realized.

Thus, a $2,500 loss would have been recognized at December 31, 20X5 (250,000 francs * [.20 - .19]). Then, in 20X6, the full difference between the $.19 and $.22 (250,000 francs * .03) would be realized for a total gain of $7,500.

Answer 232

A

Gain on Import Transaction - Recorded > Settlement
Loss on Export Transaction - Recorded > Settlement

A gain on an import transaction would occur when the recorded amount is greater than the settlement amount, and a loss on an export transaction would occur when the recorded amount is greater than the settlement amount. An import transaction will result in a payable. A gain on a foreign currency payable would occur when the settlement amount is less than the recorded amount. An export transaction will result in a receivable. A loss on a foreign currency receivable would occur when the recorded amount is greater than the settlement amount.

Answer 233

A

When a domestic entity engages in a
transaction with a foreign entity and
the transaction is denominated in (i.e.,
to be settled in) a foreign currency

Answer 234

A

In a foreign currency forward contract,
an exchange of currencies (or
comparable settlement) must occur as
provided by the terms of the contract.
In a foreign currency option contract,
an exchange of currencies may occur at
the option of the option holder. If the
option is exercised, an exchange of
currencies will occur; if it is not
exercised, no exchange of currencies
will occur.

Answer 235

A

Hedging

2. Speculation

Answer 236

A

Agreement to exchange units of
currencies at a specified future date at
an exchange rate set now

Answer 237

A

An agreement (contract) to buy or sell
(or that give the right to buy or sell) a
specified commodity in the future at a
price (rate) determined at the time the
forward contract is executed

Answer 238

A

An agreement that gives the right
(option) to buy or sell a specified
amount of a foreign currency at a
specified (forward) rate during or at the
end of a specified time period

Answer 239

A

Export - Yes
Lending - Yes
Investing - Yes

Any transaction denominated (that is, to be settled) in a foreign currency is a foreign currency transaction, including import, export, borrowing, lending, and investing transactions.

Answer 240

A

I only.

A foreign currency forward exchange contract will result in the exchange of currencies (Statement I). Unlike foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, foreign currency forward exchange contracts establish an obligation to exchange currencies.

Answer 241

A

Occur only when initiated by a foreign entity.

Foreign currency transactions do not occur only when initiated by a foreign entity. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency, regardless of whether the transaction is initiated by the domestic entity or the foreign entity.

Answer 242

A

Hedge Risk - Yes
Speculate - Yes

Forward exchange contracts may be used both to hedge risk and to speculate. When used to hedge risk, the intent is to use the change in value of the forward exchange contract (hedging instrument) to offset, in part at least, an opposite change in value of whatever is being hedged (hedged item). When used to speculate, the forward exchange contract is entered into with the intent of making a profit on the change in its value.

Answer 243

A

Foreign Currency Forward Exchange Contract - Yes
Foreign Currency Option Contract - No

While a foreign currency forward exchange contract entered into for speculative purposes is likely to result in a foreign currency loss (or gain) for the contract holder, a foreign currency option contract entered into for speculative purposes is not likely to result in a foreign currency loss for the contract holder.. Since the contract holder has the option of whether or not to exercise the contract option to exchange currencies, it is not likely that the option would be exercised if it would result in a loss.

Answer 244

A

Foreign Currency Forward Exchange Contracts - Yes
Foreign Currency Option Contracts - Yes

Both foreign currency forward exchange contracts, which establish an obligation to exchange currencies, and foreign currency option contracts, which give the right (but not an obligation) to exchange currencies, are forward contracts for accounting purposes.

Answer 245

A

Transaction Denominated In - Non-Dollars
Transaction Measured In - Dollars

For a U.S. entity, a foreign currency transaction will be denominated (settled) in non-dollars, but measured and recorded on the U.S. entity’s books in dollars.

Answer 246

A

Operating Transactions - Yes
Forward Exchange Contract Transactions -Yes

Either operating transactions (export, import, lending, borrowing, investing, etc.) or forward exchange contract transactions (contracts to exchange currencies) could be foreign currency transactions. A foreign currency transaction occurs when a domestic entity (e.g., U.S. entity) agrees to settle a transaction (pay, receive, exchange, etc.) in a non-domestic (e.g., non-dollar) currency.

Answer 247

A

A U.S. entity purchases goods from a British entity to be settled in pounds sterling.

If a U.S. entity purchases goods from (or sells goods to) a British entity and the U.S. entity is to settle in a currency other than the dollar (pounds sterling), it is a foreign currency transaction to the U.S. entity (but would not be to the British entity). A foreign currency transaction occurs when a domestic entity agrees to settle a transaction in a foreign currency.

Answer 248

A

There is no separate risk being hedged.
The forward contract and the resulting
loss or gain are recorded in earnings.

Answer 249

A

Both I and II.

A firm that engages in a forward contract will both incur fees imposed by the counterparty and incur the cost of the difference between the spot rate and the forward rate at the time the forward contract is executed. The difference between the spot rate and the forward rate is the premium (or discount) on the forward contract and must be amortized over the life of the contract as a financing expense, not an exchange gain or loss.

Answer 250

A

II only.

Because a hedging instrument is intended to offset changes in the hedged item, when the hedged item is a receivable, the hedging instrument would have to be a payable.

Answer 251

A

I, II, and III.

The net effect of a change in value of a hedged item and its related hedging instrument may be a gain, a loss, or neither a gain nor a loss (a perfect hedge).

Answer 252

A

Spot Rate - Yes
Forward Rate - Yes

Both the spot rate and the forward rate will be used in accounting for a forward contract used for hedging. The forward rate is used as the basis for determining the change in value of a forward contract. As the forward rate changes, so also will the carrying value of the forward contract, resulting in exchange gains and losses. The spot rate is used to determine the premium or discount on the forward contract. Specifically, the difference between the spot rate and the forward rate at the date of the forward contract is the premium (or discount) on the forward contract, which enters into the determination of income over the life of the contract.

Answer 253

A

Assures no gain or loss on the item being hedged.

While the intent of hedging is to mitigate the risk of loss (or gain) attributable to the item being hedged, hedging does not assure that no gain or loss will be incurred on the hedged item. Only in a perfect hedge does no gain or loss occur. In order to be a perfect hedge, the hedging instrument would need to have a 100% inverse correlation to the hedged item. Such an outcome is rare.

Answer 254

A

Offsets the risk of exchange rate
changes on a firm commitment
denominated in a foreign currency for a
future purchase or sale

Answer 255

A

The loss or gain should be reported in

current income.

Answer 256

A

Offsets risk of exchange rate changes
on non-firm but budgeted foreign
currency transactions between the
time the transaction is planned and
when it becomes firm

Answer 257

A

The commitment being hedged
must be firm, be identified, and
present exposure to foreign
currency price changes.

The forward contract must be
designated and effective as a
hedge of a commitment and
must be in an amount that does
not exceed the amount of the
commitment

Answer 258

A

Offsets the risk of exchange rate
changes on non-firm but budgeted
transactions denominated in a foreign
currency

Answer 259

A

The gain or the loss should be deferred
and reported as a component of other
comprehensive income.

Answer 260

A

The forecasted transaction must
be identified, probable of
occurring, and present an
exposure to foreign currency
price changes; and

Use of a forward contract to
hedge must be consistent with
company risk management
policy.

Answer 261

A

Hedges exposed receivables or
payables to offset the risk of exchange
rate changes on already booked assets
and liabilities denominated in a foreign
currency

Answer 262

A

Offsets the risk of exchange rate
changes on this class of investments
denominated in a foreign currency

Answer 263

A

Offsets the risk of exchange rate
changes on firm commitments for a
future purchase or sale to be
denominated in a foreign currency

Answer 264

A

The hedge of a firm commitment can
be either a fair value hedge or a cash
flow hedge.

Answer 265

A

A cash flow hedge

Answer 266

A

Offsets risk of exchange rate changes

on an investment in a foreign operation

Answer 267

A

The hedged item is for an already booked asset or liability.

A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. Therefore, an asset or liability has not been booked (recognized) already.

Answer 268

A

Both I and II.

Both Statement I and Statement II are correct. Even though a firm commitment is hedged, a net gain or loss can be reported (Statement I) if the changes in value of the firm commitment (hedged item) and the forward contract (hedging instrument) are not identical. Additionally, as a result of hedging a firm commitment, an otherwise unrecognized asset or liability may have to be recognized (Statement II) to offset any gain or loss recognized on the forward contract.

Answer 269

A

$200

The ineffective portion of the (cash flow) hedge should be reported in current income. The effective portion of the hedge ($3,800) should be reported in other comprehensive income, and the ineffective portion ($200) should be reported in current income. The effective portion of the hedge is the amount of change in the forward contract (hedging instrument) equal to the change in the fair value of the expected sale amount (the hedged item) ($3,800); the ineffective portion is the difference ($200) and should be reported in current income.

Answer 270

A

A net investment in a foreign operation.

A hedge to offset the risk of exchange rate changes on converting the financial statements of a foreign subsidiary to the domestic (functional) currency would be the hedge of a net investment in a foreign operation. Changes in exchange rates will result in changes in the amount of domestic (functional) currency that will result from converting (translating) financial statements from a foreign currency. Hedges of net investments in a foreign operation are intended to offset that risk.

Answer 271

A

Firm Purchase Commitments - Yes
Firm Sales Commitments - Yes

Both firm purchase commitments and firm sales commitments can be hedged. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirements of GAAP. The risk of an exchange rate change on the contract is the same as if the purchase or sale had been recognized, and such risk can be hedged.

Answer 272

A

Cash Flow - Yes
Fair Value - Yes

A forward contract used to hedge a foreign currency firm commitment can be either a cash flow hedge (as permitted by the FASB’s Derivatives Implementation Group) or a fair value hedge (as permitted by FASB #133).

Answer 273

A

Planned Sale - Yes
Planned Purchase - Yes

Either a planned sale or a planned purchase would be a forecasted transaction and, if denominated in a foreign currency, could be hedged.

Answer 274

A

Forecasted transaction -> firm commitment -> recognized liability.

A forecasted transaction (a planned or expected transaction) would occur before a firm commitment, which would occur before a recognized liability. A forecasted transaction is a non-firm but intended (perhaps even budgeted) transaction. A firm commitment exists when an entity has a contractual obligation or right, but has not yet recorded the obligation or right because it does not meet the requirement of GAAP. A recognized liability would be one that is already booked by the entity. Thus, the correct sequence would be forecasted transaction -> firm commitment -> recognized liability.

Answer 275

A

Offsets the risk of exchange rate

changes on an existing asset or liability

Answer 276

A

Offsets risk of exchange rate changes
on translation of financial statements
of foreign operation from foreign
currency to dollars

Answer 277

A

Offsets the risk of exchange rate
changes on a foreign currency–
denominated investment in securities
classified as available for sale.

Answer 278

A

The asset or liability is
denominated in a foreign
currency and has already been
booked.

The gain or loss on the hedged
asset or liability must be
recognized in earnings.

Answer 279

A

The securities being hedged must
be identified and must not be
traded in the investor’s currency.

The forward contract must be
designated and highly effective
as a hedge of the investment, and
in an amount that does not
exceed the amount of the
investment being hedged.

Answer 280

A

The use of a hedge instrument to hedge
net investment in foreign operations
requires that the contract:

Is designated as a hedge of net
investment and

Is highly effective.

Answer 281

A

Either a cash flow hedge or a fair value

hedge

Answer 282

A

A fair value hedge

Answer 283

A

A fair value hedge

Answer 284

A

Between the dates an asset is recognized and when the asset is fully satisfied.

The time between when an asset is recognized and when the asset is fully satisfied would be intended to offset the risk of changes in the exchange rate on a recognized asset (or liability).

Answer 285

A

I only.

Statement I is correct; Statement II is not. In the hedging of an investment in a foreign operation, the hedged item is the result of translating the foreign operation’s financial statements from a foreign currency to the functional currency (Statement I). The intent of the hedge is to offset changes in the translated results that are caused by changes in exchange rates. Statement II is not correct; either derivatives (e.g., forward contracts) or non-derivatives can be used to hedge an investment in a foreign operation. For example, borrowing in the same foreign currency would hedge the investment, but the borrowing is not necessarily a derivative (e.g., forward contract).

Answer 286

A

Borrow from another foreign entity with the same foreign currency as the operation being hedged.

Borrowing from another foreign entity with the same foreign currency as the operation being hedged would hedge the (equity) investment in the foreign operation. Since the equity investment in a foreign operation is an asset and the borrowing would be a liability, both in the same foreign currency, a change in the exchange rate would have offsetting effects. Thus, if an exchange rate change caused a decrease in the value of the investment (asset), it would cause an increase in the value of the borrowing (liability).

Answer 287

A

Either I or II.

The hedge of a recognized asset or liability may be either a fair value hedge or a cash flow hedge, depending on management’s designation. However, the hedge of a recognized asset or liability denominated in a foreign currency generally will be a cash flow hedge.

Answer 288

A

Both I and II.

Both Statement I and Statement II are correct. In hedging a foreign currency investment held available-for-sale, the investment security must not be traded in the investor’s functional currency, and the forward contract used as the hedging instrument must be highly effective in hedging the investment.

Answer 289

A

$7,000

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.

Answer 290

A

$3,000

The gain (or loss) recognized on the contract will be computed as the number of Euros to be purchased (100,000E) multiplied by the change in the forward exchange rate between the date the contract was executed ($1.80) and the end of the fiscal period, December 31, 20X8 (1.83). Therefore, the gain recognized will be 100,000E × ($1.83 − $1.80 = $0.03) = $3,000. It is a gain because the forward contract increased in value as of December 31. The gain on the forward contract will partially offset the loss on the inventory for the period. A complete determination of the gain on the forward contract (only) would include amortization of the difference between the spot rate and forward rate at the initiation of the contract ($6,000) and discounting the nominal gain of $3,000 for the period December 31 to the March settlement date.

Answer 291

A

I only.

The hedge of an available-for-sale investment denominated in a foreign currency is a fair value hedge. The risk hedged is the effect of exchange rate changes on the fair value in dollars of the investment.

Answer 292

A

There is no separate risk being hedged.
The forward contract and the resulting
loss or gain are recorded in earnings.

Answer 293

A

The forward exchange contract is
measured (valued) and recorded at the
forward exchange rate (quoted now)
for exchanges that will occur at the
maturity date of the contract. Any
change in value resulting from
changing forward exchange rates will
be recognized in current income.

Answer 294

A

To make a gain as a result of exchange
rate changes by buying foreign
currency for future delivery at a price
lower than its value when delivered or
by selling foreign currency for future
delivery at a price higher than it can be
bought at delivery date.

Answer 295

A

$2,500

A futures contract entered into for speculative purposes (not to hedge) is valued using futures rates, and any gain or loss as a result of changes in futures rates is recognized in net income in the period during which the rate changed. At initiation of Platt’s contract, the 90-day futures rate was $.70, as quoted in the contract. On December 31, 20X5, 30 days before Platt’s contract was to be settled, the 30-day futures rate was $.65. Platt’s loss would be computed as follows:

November 2, 20X5, 50,000 Swiss francs × $.70 = $35,000

December 31, 20X5, 50,000 Swiss francs × $.65 = $32,500

Loss in dollar value of futures contract = $2,500

Answer 296

A

I only.

When used for speculative purposes, a forward contract is not entered into to offset, or hedge, an existing risk. Rather, the purpose of entering into a speculative forward contract is to make a profit. Statement II is not correct. Changes in the value of a forward contract used for speculative purposes, measured using the forward rate, are recognized in the period in which the forward rate changes and are not deferred until the contract matures.

Answer 297

A

Spot Rate - No
Forward Rate - Yes

The forward rate is used, and the spot rate is not. When a forward contract is entered into for speculative purposes, the contract is measured using the forward rates as of the dates the contract is initiated and at any subsequent measurement date(s) (e.g., balance sheet date). Changes in the forward rate create gains and losses on the forward contract, which are recognized in the period in which the forward rate changes.

Answer 298

A

Either a cash flow hedge or a fair value hedge, at management’s discretion.

A hedge to offset the risk of loss on a recognized asset or liability could be either a cash flow hedge or a fair value hedge, at management’s discretion. If the risk of loss on the recognized asset or liability being hedged is from changes in exchange rates, the hedge would be classified as a cash flow hedge.

Answer 299

A

Either a cash flow hedge or a fair value hedge, at management’s discretion.

A hedge to offset the risk of loss on a recognized asset or liability could be either a cash flow hedge or a fair value hedge, at management’s discretion

Answer 300

A

Net investment in foreign operations hedge.

The hedge of a net investment in foreign operations is a fair value hedge, but changes in the fair value of the forward contract (hedging instrument) that are equal to or less than the change in the translated value of the financial statements of the foreign operation are reported as a translation adjustment in other comprehensive income. The change in the forward contract reported as a translation adjustment offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.

Answer 301

A

Net investment in foreign operations hedge.

The hedge of a net investment in foreign operations offsets the change in the value of the translated financial statements of the foreign operation, which also are reported as a translation adjustment.

Answer 302

A

$3,000

All gains and losses in a speculative forward foreign exchange contract are included in income of the period in which the forward exchange rate changes. Gains and losses are measured based on the purchase price of the contract and its current settlement value using forward rates.

In this case, those rates are the $.90 purchase price (forward rate December 12) and the $.93 settlement price (forward rate December 31). Thus, this $3,000 amount is correct [($.93-$.90)100,000].

Answer 303

A

$1,000

The correct answer is the difference between the 60-day forward rate on September 1 of $0.74 and the 30-day forward rate on September 30 of $0.72, or $0.02 × 50,000 Euros = $1,000, the correct amount of the loss.

Answer 304

A

$100

Forward contracts are derivatives, and all derivatives are recorded at fair value with unrealized gains and losses recorded in earnings. (The only exception is for certain derivatives that qualify for hedge accounting.) The forward contract price is at $2.05 on November 1, and the forward price increased to $2.06 on December 31. Kir is in a gain position because the November forward contract to buy (Kir’s strike price) is less than the December forward price. The 10,000 British pounds times $.01 is $100 gain.

Answer 305

A

When a foreign entity generates most
of its cash flows in the currency of
another foreign country or when it is
required to use another currency by
law or contract.

Answer 306

A

It is the currency of the primary
economic environment in which an
entity operates and generates net cash
flows. It can be the recording currency,
an affiliate's reporting currency, or
another currency.

Answer 307

A

The functional currency would be the
reporting currency:

When the foreign entity is a direct
and integral component or
extension of a U.S. entity’s
operations; or

When the local economy of the
foreign entity is highly
inflationary.

Answer 308

A

It is the currency in which an entity
maintains its books of accounts.
Normally, the recording currency is the
local currency of the country in which
an entity is located.

Answer 309

A

When operations of the foreign entity
are relatively self-contained and
integrated within the country in which
it is located, and the economy of that
country is not in hyperinflation.

Answer 310

A

It is the conversion (translation) of
financial statements expressed in one
currency into comparable financial
statements expressed in another
currency.

Answer 311

A

It is the currency in which final financial

statements are expressed.

Answer 312

A

Translation may be needed to:

Apply the equity method of
accounting to an investee.

Prepare combined financial
statements.

Prepare consolidated financial
statements.

Answer 313

A

Equity Investee - Yes
Subsidiary to be Consolidated - Yes

The financial statements expressed in a foreign currency needing to be converted to a domestic currency could be those of either an equity investee or a subsidiary to be consolidated (or a branch, a joint venture, a partnership, or any other separate foreign operation).

Answer 314

A

The subsidiary makes all of its product for sale to and for use by its U.S. parent.

If a subsidiary makes all of its product for sale to and for use by its parent, the subsidiary is likely to be a direct and integral extension of its parent and, therefore, the parent’s currency is likely to be the functional currency, not the local foreign currency of the subsidiary. In the circumstances described, the subsidiary likely receives virtually all of its cash inflow from its parent, which it converts to the local currency for operating costs. Therefore, it generates most of its cash flows in the U.S. dollar, and that is its functional currency, not the local foreign currency.

Answer 315

A

The currency of the primary economic environment in which the subsidiary operates and generates most of its net cash flow.

The functional currency of a foreign subsidiary would be the currency of the primary economic environment in which the subsidiary operates and primarily generates and expends cash. That currency could be the recording currency, the reporting currency, or another foreign currency.

Answer 316

A

Current exchange rate

Operating transactions denominated in a foreign currency are converted to the functional currency using the current (or spot) exchange rate. The current (or spot) exchange rate is the exchange rate in effect at the current time (or as close thereto as possible); that is, at the time of the transaction or revaluation.

Answer 317

A

II and III, only.

The functional currency could be either the recording currency of the foreign entity (Statement II) or the reporting currency of a parent (Statement III) (or even another foreign currency). The functional currency will be the currency of the primary economic environment in which an entity operates and primarily generates and expends cash, not whatever currency management chooses (Statement I).

Answer 318

A

Both I and II.

Determining a foreign subsidiary’s functional currency will take into account both the extent to which the subsidiary operates, and generates and expends cash in the local foreign economy in which it is located and the cumulative inflation rate of that economy.

Answer 319

A

The reporting currency.

The reporting currency is the currency in which the final consolidated financial statements are presented (reported).

Answer 320

A

The functional currency of the subsidiary.

The method to be used to convert financial statements of a subsidiary from a foreign currency to the parent’s currency depends primarily on the functional currency of the subsidiary. Whether the functional currency of the subsidiary is the local foreign currency, the parent’s currency, or another foreign currency will determine the conversion method or methods to be used.

Answer 321

A

I, II, and III.

The functional currency of a foreign subsidiary could be the recording currency of the foreign subsidiary, the reporting currency of the subsidiary’s parent, or a currency other than either the recording currency of the subsidiary or the reporting currency of its parent.

Answer 322

A

The spot exchange rate (closing rate) as

of the balance sheet date

Answer 323

A

The exchange rate that existed
when the items was earned or
incurred; or
The average exchange rate for
the period, if that is not
materially different than the
actual rates when earned or
incurred

Answer 324

A

The historic exchange rate that existed
when the paid-in capital items arose,
but not earlier than when the
investment in the entity was initially
made

Answer 325

A

Retained earnings is not translated but
rather is calculated as of the balance
sheet date. The calculation is:

Beginning retained earnings ($) +
Translated net income / –Net loss ($) –
Dividends declared translated at the
spot rate at date of declaration =
Ending retained earnings ($)

Answer 326

A

Cash.

When converting financial statements from a foreign currency to a reporting currency using translation, assets and liabilities are translated using the spot (or current) exchange rate as of the balance sheet date, not the weighted average exchange rate for the period. Therefore, cash could not be translated using the weighted average exchange rate for the fiscal year.

Answer 327

A

$17,000

The correct amount of foreign exchange loss is $17,000. The $4,000 loss on the account payable ($64,000 − $60,000 = $4,000) would be included in net income. Therefore, the correct amount of foreign exchange loss is $13,000 + $4,000 = $17,000. The translation loss (or gain) would not be included in net income for the year, but rather would be reported as an item of other comprehensive income (outside net income) for the year.

Answer 328

A

Wages Expense - Yes
Sales to Customers - Yes

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. Therefore, the weighted average exchange rate for the current year would be an appropriate rate for converting both wages expense and sales to customers.

Answer 329

A

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.

Answer 330

A

Common stock.

When converting financial statements from a foreign currency to a reporting currency using translation, paid-in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using the spot (or current) exchange rate as of the balance sheet date, but the historic exchange rate for the common stock.

Answer 331

A

$1,290

Since translation should be used to convert Sanco’s financial statements expressed in FCUs to U.S. dollars, dividends declared should be translated at the exchange rate in effect when the dividends were declared (the same would be true for remeasurement). In this case, the exchange rate is given as 1 FCU = $1.290. Therefore, the correct dollar amount of Sanco’s dividends declared would be 1,000 FCUs × $1.290 = $1,290.

Answer 332

A

$1,300

Since translation should be used to convert Sanco’s financial statements expressed in FCUs to U.S. dollars, depreciation expense should be converted using the exchange rate in effect when depreciation was incurred during the year or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sanco’s depreciation expense would be 1,000 FCUs × $1.300 = $1,300.

Answer 333

A

Retained earnings.

When converting financial statements from a foreign currency to a reporting currency using translation (or remeasurement), retained earnings is not translated using an exchange rate. Rather, retained earnings is calculated using already converted values. Specifically, beginning retained earnings in dollars + converted net income - converted dividends declared = ending retained earnings in dollars.

Answer 334

A

Common stock.

When converting financial statements from a foreign currency to a reporting currency using translation, paid-in capital accounts are translated using the historic exchange rate in effect when the account amount arose (or when the investment was made, if later). Therefore, common stock would not be translated using either the spot (or current) exchange rate as of the balance sheet date or the weighted average exchange rate for the period, but the historic exchange rate for the common stock.

Answer 335

A

Remeasurement is used when
converting from a recording currency
(that is not the functional currency) to
the functional currency. This might
occur, for example, when:

The recording currency is in a
highly inflationary economy.
The operations of the foreign
entity are a direct and integral
component or extension of its
parent.

The functional currency is not the
local foreign currency but
another foreign currency (other
than the reporting currency).

Answer 336

A

The adjustment is reported as a
translation gain or loss in the income
from the continuing operations section
of the income statement.

Answer 337

A

Conversion method used to convert
accounts from foreign currency units to
dollars

Answer 338

A

Current (spot) exchange rate

Answer 339

A

Historic exchange rate.

Answer 340

A

Depreciation expense.

Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, most expenses (and revenues, gains, and losses) are converted using the current exchange rate. Expenses related to assets and liabilities converted at a historic rate are an exception - they are converted using a historic exchange rate. Therefore, since depreciation expense does result from an asset (property, plant, and equipment) measured using a historic exchange rate, depreciation expense would be remeasured using a historic exchange rate.

Answer 341

A

$15,600

Since remeasurement should be used to convert Sapco’s financial statements expressed in FCUs to U.S. dollars, and since sales is not an income statement item derived from a balance sheet item remeasured using a historic cost, sales should be converted using the current exchange rate in effect when each sale took place or the weighted average exchange rate for the period. In this case, the weighted average exchange rate for the period is given as 1 FCU = $1.300. Therefore, the correct dollar amount of Sapco’s sales would be 12,000 FCUs × $1.300 = $15,600.

Answer 342

A

Monetary and non-monetary.

The distinction used for applying different exchange rates to different accounts when using remeasurement is based on whether the account is monetary or non-monetary.

Answer 343

A

As income from continuing operations.

Under the remeasurement method of converting from a foreign currency to a reporting currency, any resulting loss (or gain) is reported as an item of income from continuing operations in current income.

Answer 344

A

As an item in income from continuing operations.

When remeasurement is used to convert financial statements expressed in a foreign currency to a reporting currency, any resulting translation adjustment (gain or loss) is reported as an item in income from continuing operations.

Answer 345

A

Remeasurement.

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.

Answer 346

A

Remeasurement.

Because Sapco’s operations are a direct extension of Papco, Sapco’s local foreign currency is not its functional currency. Rather, Papco’s currency, the U.S. dollar, is Sapco’s functional currency. Therefore, its financial statements expressed in the foreign currency will be converted to U.S. dollars using remeasurement.

Answer 347

A

Cash.

Under the remeasurement method of converting financial statements from a foreign currency to a reporting currency, monetary assets and liabilities are converted using the current exchange rate, not a historic exchange rate. Therefore, cash (the most monetary of assets) would be converted using the current exchange rate, not a historic exchange rate.

Answer 348

A

$7,800

Since remeasurement should be used to convert Sapco’s financial statements expressed in FCUs to U.S. dollars, inventory should be converted using the historic exchange rate in effect when the inventory was acquired. In this case, the inventory was acquired evenly during 20X8 and the weighted average exchange rate for the year was $1.300. Therefore, the correct dollar amount of Sapco’s inventory would be 6,000 FCUs × $1.300 = $7,800.

Answer 349

A

The financial statements are first
remeasured from the recording
currency to the functional currency and
then translated from the functional
currency to the reporting currency.

Answer 350

A

$8,100

Gains and losses from translation are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur; gains and losses from remeasurement enter into the determination of net income in the period in which the gains or losses occur. Therefore, the correct answer is $8,100, the gain from translation.

Answer 351

A

Translation Adjustment - Other comprehensive income
Remeasurement Adjustment - Net Income

An adjustment resulting from translation of financial statements would be reported in other comprehensive income, and an adjustment resulting from remeasurement would be reported in net income.

Answer 352

A

Remeasurement and then translation.

Remeasurement and then translation would be used to convert to the reporting currency when a foreign currency other than the foreign subsidiary’s recording currency is the functional currency. Specifically, the financial statements would be remeasured from the recording currency to the other foreign functional currency, and the remeasured financial statements would then be translated to the reporting currency

Answer 353

A

$1.55

Since Gordon prepares its financial statements in its local currency, the British pound, and since the British economy has not been in hyperinflation, Gordon’s functional currency would be the British pound, and its financial statements would be converted to U.S. dollars using translation, not remeasurement. Under the translation method of converting, income statement items are converted using the average exchange rate for the period.

Answer 354

A

$7,600

Gains and losses from remeasurement enter into the determination of net income in the period in which the gains and losses occur. Gains and losses from translation do not enter into the determination of net income, but are recognized in other comprehensive income (outside of net income) in the period in which the gains and losses occur. Therefore, the correct answer is $7,600, the gain from remeasurement.

Answer 355

A

The lessee does not record
depreciation under an operating
lease.

The lessee amortizes the right-ofuse
asset.

Answer 356

A

A lease that transfers the control (or
ownership) of the leased asset to the
lessee.

The lessee records a right-of-use asset
and lease liability. The lessee amortizes
the right-of-use asset and recognizes
interest expense.

Answer 357

A

A lease that does not meet any of the
finance lease criteria and has a lease
term longer than 12 months.

Answer 358

A

The lessee calculates an interest
component and an amortization
component based on the right-of-use
asset.
Annual lease expense is recognized
evenly over the lease period, but the
amount of the lease expense
represented by each component
changes over time.
In other words, the lease expense
remains the same each period. The
proportion of the interest component
and amortization that contribute to the
lease expense amount changes over
time

Answer 359

A

The lessor records annual lease
or rent revenue.

The lessor retains the leased
asset on its books.

The lessor records annual
depreciation for the leased asset.

Answer 360

A

The lessee used the effective interest
method to calculation the interest
component based on the interest rate
and the lease liability balance.

Answer 361

A

Lease liability—Balance Sheet
Right-of-use asset—Balance Sheet
Lease expense—Income Statement
Also note that accounts payable and
cash may be impacted

Answer 362

A

$338,000.

At the inception of a lease, the lessee records a lease liability. To be considered a finance lease, a lease must satisfy any one of the five criteria specified in ASC Topic 842. This lease does not satisfy any of the five criteria. The lease has no bargain purchase option and does not transfer title. The lease term is not 75% or more of the useful life (10 years out of 15 years is 67%), and the PV of the lease payments is not 90% or more of the FV of the asset [(6.76 × $50,000) / $400,000 = 84.5%]. Therefore, this is an operating lease, not a finance lease. The lessee will record a lease liability of $338,000 ($50,000 annual payment multiplied by the present values of an annuity due factor of 6.76).

Answer 363

A

The lease should be classified as an operating lease, and a lease liability should be recorded at the inception of the lease.

The lease exceeds 12 months but does not meet any of the classification criteria for a finance lease. Marnie should classify this lease as an operating lease and record a lease liability at the inception of the lease.

Answer 364

A

Recording the expense as time passes, likely recognizes the expense on a monthly basis.

Because this is a short-term lease, the lease expense is the amount associated with the expense of leasing that asset typically recognized on a monthly basis.

Answer 365

A

$28,800

The lease liability at the inception is recorded as $338,000 ($50,000 × Present value factor of an annuity due 6.76). The first payment made on the date of inception is applied entirely to the lease liability because no time has passed for interest to accrue. The lease liability balance is $288,000 for the first year. Multiply the lease liability balance of $288,000 by the implicit interest rate of 10% to calculate the amount of the first year’s lease expense attributable to interest: $288,000 × 10% = $28,800.

Answer 366

A

$26,667

The lease is an operating lease, and Sussex retains the asset on its books. Sussex uses the straight-line method of depreciation and depreciates the asset over its useful life. Because no cost is given, we assume the cost is equal to the fair value of the machine. To calculate depreciation expense, Sussex divides the fair value or cost basis ($400,000) by the useful life (15 years). Depreciation equals $26,667.

Answer 367

A

The fixed noncancelable term of the lease plus
periods covered by bargain renewal options plus all
periods covered by renewal options during which
there is a loan outstanding from the lessor to the
lessee

Answer 368

A

An option whereby the lessee has the opportunity to
purchase the asset at an amount that is significantly
less than the asset’s expected fair value at the end of
the lease term

Answer 369

A

Costs for insurance, maintenance, and taxes

Answer 370

A

The lessor’s desired rate of interest or desired rate of

return.

Answer 371

A

The rate, at lease inception date, the lessee would
have incurred to borrow the funds necessary to
purchase the leased asset

Answer 372

A

Meet one or more of the following:
Lease transfers ownership.
Lease contains a bargain purchase option.
Lease term is 75% or more of useful life.
Present value of minimum lease payments is
90% or more of market value.
The asset does not have an alternative use.

Answer 373

A

Interest rate implicit in the lease

Answer 374

A

Direct financing

2. Sales type

Answer 375

A

$900,000

The lessee capitalizes the lease at the lesser of the present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Because the fair value of the equipment is less than the present value of the minimum lease payments, Arena Corp. will report a lease liability of $900,000.

Answer 376

A

The lease contains a bargain purchase option.

A bargain purchase option is one of the five criteria for a finance lease to be recorded by the lessee. Only one criterion needs to be met. A bargain purchase option implies that, at inception, the lessee will purchase the asset at the end of the lease term because the option price will be significantly below the market price of the asset at that time.

Meet one or more of the following:
Lease transfers ownership.
Lease contains a bargain purchase option.
Lease term is 75% or more of useful life.
Present value of minimum lease payments is
90% or more of market value.
The asset does not have an alternative use.

Answer 377

A

The fair value of the computers on January 1, year 1 is $14,000.

There are five criteria for a finance lease. In summary, they are:
The lease agreement transfers ownership of the leased asset to the lessee at the conclusion of the lease term (Title transfer).
Bargain purchase option
Lease term is 75% or more of estimated economic life
Present value of minimum lease payments at least 90% of excess of fair value of leased property.
The asset does not have an alternative use.
This answer meets item #4 above.

Answer 378

A

The lease contains a bargain purchase option.

A bargain purchase option is one of the five finance lease criteria. The option allows the lessee to purchase the asset at the end of the term for significantly less than the estimated market value at that time. Thus, the lease arrangement is considered an installment purchase because the lessee is expected to exercise the option.

Meet one or more of the following:
Lease transfers ownership.
Lease contains a bargain purchase option.
Lease term is 75% or more of useful life.
Present value of minimum lease payments is
90% or more of market value.
The asset does not have an alternative use.

Answer 379

A

Lease M - Finance lease
Lease P - Finance lease

Both are finance leases. The relevant criterion for a finance lease in this question is:

If the lease term is equal to or greater than 75% of the remaining useful life of the asset at the inception of the lease, then the lease is a finance lease.

Only one of five criteria must be met for a lessee to account for the lease as a finance lease. Transfer of ownership is not required.

The rationale for this criterion is that if 75% of the useful life is used by the lessee, then substantially all of the rewards and obligations of ownership have been passed to the lessee.

Answer 380

A

Lower of implicit rate or incremental

borrowing rate

Answer 381

A

Annual lease payments

Bargain purchase option

Lessee guarantee of residual less the expected
residual value of the asset at the end of the
lease

Answer 382

A

Fair value of asset leased

Answer 383

A

It makes a difference for the lessor only.

Answer 384

A

$2,675,000

The amount to be capitalized is the present value of the lease payments. This amount is $2,675,000 ($500,000 × 5.35) and should be equal to the market value of the equipment if the useful life is also 7 years.

Although $3,500,000 (7 × $500,000) will be paid by Koby over the lease term, the difference between that amount and $2,675,000 represents interest to be recognized over the term. The $2,675,000 amount is the current sacrifice required to obtain the use of the equipment and should be close to the purchase price if the equipment is available by purchase.

If Koby invested that amount at the interest rate implied in the lease, the investment would be sufficient to cover all seven payments.

Answer 385

A

$15,227

This lease is capitalized because the present value of the lease payments is 90% or more of the fair value of the asset (in this case, 100%). The capitalized lease liability at inception is $60,000 × 5.0757 = $304,542. Interest expense at the end of the first year is .05 × $304,542 = $15,227. A capitalized lease liability is much like a mortgage note with payments including both principal and interest. The principal portion of the first payment is $60,000 − $15,227, or $44,773.

Answer 386

A

$75,816.

The $75,816 lease liability at December 31, 20X5 is the initial liability at inception less the first payment, which is completely a principal payment. The first payment occurs at inception and therefore could have no interest component. The initial liability at inception is the present value of an annuity due of six periods.

Ending 20X5 lease liability = liability at inception − $20,000 first payment
= $20,000(4.7908) − $20,000
= $75,816

The lessee must use the lower of its incremental borrowing rate (11%) and the rate implicit in the lease (10%), hence the use of the 4.7908 present value factor.

Answer 387

A

$111,500.

The entry at December 31, 20X5:

Dr.Interest expense ($112,500 × .08) 9,000
Dr. Lease liability 1,000
Cr. Cash 10,000

The ending lease liability for 20X5 is $111,500 ($112,500 − $1,000 from entry).

Answer 388

A

Minimum lease payment less the portion of the minimum lease payment allocable to interest.

Each lease payment includes interest based on the lease liability at the beginning of the period. The amount of each payment exceeding the interest component is the amount of principal reduction. This amount reduces the lease liability used to compute the interest portion of the next payment.

Thus, the interest component decreases with each payment as more principal is paid off.

Answer 389

A

$37,900

The beginning lease liability balance at 1/1/X4 is $379,000. That balance is unchanged the entire year because the first lease payment is made 1 year later. Therefore, the interest expense for the first year is $37,900 (.10 × $379,000).

Answer 390

A

Interest income and gross profit

Answer 391

A

Fair value of asset leased

Answer 392

A

Lease liability

Answer 393

A

Immediate recognition of full sales amount (fair

value of asset)

Answer 394

A

The amount recognized is book value of the asset

under lease.

Answer 395

A

Increase by total interest (Sum of lease payments –
Fair value of asset) + Gross profit (Fair value of asset
– Book value of asset)

Answer 396

A

$533,600.

The ending Year 2 lease liability balance is the present value of remaining payments and also equals the initial lease liability amount less the principal portion of the first two payments.

The first payment is made at the inception and therefore is all principal. It reduces the lease liability by $100,000. The opening Year 2 lease liability balance is $676,000 − $100,000 or $576,000.

Dr. Interest expense .10($576,000) 57,600
Dr. Lease liability 42,400
Cr. Cash 100,000
Thus, the ending Year 2 lease liability balance is $533,600 = $676,000 − $100,000 − $42,400.

Answer 397

A

Should be recognized over the period of the lease using the effective interest method.

For all sales-type leases, the lessor uses the effective interest method to compute interest over the period of the lease. The interest revenue recognized each period equals the interest rate implicit in the lease multiplied by the beginning net lease receivable.

Answer 398

A

$230,500.

The lease is a finance lease because the lease term of 6 years is 75% of the useful life of the machine (8 years). The lower of the two rates of interest must be used because Day knows the lessor’s implicit interest rate. The $230,500 lease liability is the present value of the lease payments = (4.61)$50,000.

Answer 399

A

$688,500

Action must use the 9% rate because it is the lower of the two and Action knows the lessor’s implicit rate of 9%.

The initial capitalized value is $153,000 times the present value of a 7-year annuity due because the first payment is due at inception. Multiplying the 5.5 factor by $153,000 yields the fair value of $841,500, the initial capitalized value before the first payment.

After the first payment was made, which is all principal because it was made at the inception, the remaining lease liability is $688,500 ($841,500 − $153,000).

Answer 400

A

$5,750

The interest for the first 6 months of the lease term is (1/2).10($135,000 − $20,000) = $5,750.

The first lease payment reduces the principal by the full amount of the payment because no time has elapsed since inception (it was paid essentially at the inception of the lease). When the fiscal year is not specified, the student should assume a calendar fiscal year. Therefore, as of 12/31/X5, only 6 months of the term had elapsed.

Answer 401

A

Interest expense - No
Lease liability - Yes

The first payment, which is made at inception, is completely a principal payment because no time has elapsed in the lease term. Thus, the entire payment is applied to principal and reduces the lease liability by the amount of the payment.

Answer 402

A

The lease does not meet any of the five lease
criteria for a sales-type lease.
The residual value is guaranteed by a third
party.

Answer 403

A

The lessor finds the interest rate that will amortize
the net lease receivable down to zero based on the
annual lease payments, which were determined
using the implicit interest rate.

Answer 404

A

Deferred gross profit is the difference between the
fair value of the asset and the carrying amount of the
asset.

Answer 405

A

Net lease receivable = Gross lease receivable –

Deferred gross profit

Answer 406

A

The lessor calculates the interest on the gross lease
receivable based on the implicit interest rate (given
in the problem). Then the lessor calculates the
interest based on the effective interest rate
multiplied by the net lease receivable. The difference
between the interest calculations is the amount of
deferred gross profit amortized during the period.

Answer 407

A

If the residual value of the leased assets is equal to
or greater than the guaranteed residual value, then
the following journal entry is recorded:

Dr. Equipment/Inventory XX
Cr. Lease Receivable XX

If the residual value is less than the guaranteed
residual value, then the third-party guarantor will
provide consideration for the difference in amount.

Dr. Equipment/Inventory XX
Dr. Cash (diff. between GRV and RV) XX
Cr. Lease Receivable XX

Answer 408

A

$2,595

Bear records a net lease receivable of $30,000 and uses an effective interest rate of 15.85%. Bear calculates interest associated with the net receivable of $4,755. Bear also calculates interest based on the gross lease receivable ($36,000) and the implicit interest rate of 6%. Interest associated with the gross lease receivable is $2,160. The amortization of the deferred gross profit is $2,595 ($4,755 – $2,160).

Answer 409

A

$4,755

The lease revenue is calculated based on the net lease receivable and the interest rate that effectively amortizes the net lease receivable to zero at the end of the lease term. Bear has a net lease receivable of $30,000 and an interest rate to apply of 15.85%. $30,000 multiplied by 15.85% equals $4.755.

Answer 410

A

Residual value guaranteed by a third-party.

For a lease to qualify as a direct financing lease, the residual value is usually guaranteed by a third party.

A direct financing lease does not meet any of the lease criteria used to classify a sales-type lease.

A direct financing lease does not meet any of the lease criteria used to classify a sales-type lease. Typically, when the residual value is guaranteed by the lessee, the lease meets the present value test (90%).

A bargain renewal option would effectively extend the lease term, likely meeting the lease criteria associated with the majority of the asset’s useful life (75% test).

Answer 411

A

The rate that amortizes the net lease receivable to zero at the end of the lease term.

The lessor must determine the rate that will amortize the net lease receivable to zero by the end of the lease term.

The lessor applies the implicit rate to the gross lease receivable.

The incremental borrowing rate may be used by lessee’s under certain circumstances. The question focuses on the lessor.

The lessor does not focus on amortizing the gross lease receivable to zero because it includes the residual value.

Answer 412

A

The owner of property sells its asset and

immediately leases it back.

Answer 413

A

If a seller-lessee sells an asset but control does not
effectively pass to the buyer-lessor, then revenue
recognition criteria have not been met. The sellerlessee
may not account for the transaction as a sale
and instead must account for the transaction as a
financing transaction.

Answer 414

A

A short-term lease or an operating lease, not a

finance lease

Answer 415

A

The transaction is recorded in the same manner as
any other sale transaction of an asset.

Dr. Cash XX
Dr. Accumulated Depreciation XX
Cr. Equipment XX
Cr. Gain XX

The above journal entry assumes a gain. A gain or
loss is calculated based on the difference between
the sales price and the carrying amount of the asset.

Answer 416

A

Buyer-lessor
The buyer-lessor now owns and controls the asset.
They record the asset on their books and record
depreciation expense.

Answer 417

A

$0.

The transaction appears to meet the criteria of a sale, so Bain will recognize a gain of $30,000 on the sale of the equipment on the date of the sale. None of the gain is deferred.

Answer 418

A

No gain reported.

Because the lease meets the finance lease criteria, the buyer-lessor has not taken control of the asset. Able will account for the transaction as a failed sale and effectively record the effects as a financing transaction as opposed to a sale-leaseback.

Answer 419

A

Finance Lease - No
Operating Lease - Yes

If the leaseback is classified as an operating lease by the seller-lessee, then control of the asset has likely passed to the buyer-lessor and the revenue recognition criteria are met. The seller-lessee may recognize the gain at the time of the sale.

Answer 420

A

$100,000

The transaction appears to meet the sale criteria for a sale-leaseback. Assuming the buyer-lessor paid cash for the asset and pretending the asset had a cost of $500,000 and accumulated depreciation of $200,000 (made-up numbers to illustrate the journal entry), Mega would record a $100,000 gain and the following journal entry at the time of the sale transaction:

Dr. Cash $400,000
Dr. Accumulated depreciation $200,000
Cr. Equipment $500,000
Cr. Gain on sale $100,000

Answer 421

A

$400,000, the sales price

The buyer-lessor just purchased the asset for $400,000. This will serve as the cost basis of the asset at the onset of ownership.

Answer 422

A

Cost of Goods Sold

Sales Revenue

Answer 423

A

…the remaining useful life of the asset is shorter
than the lease term.
Study hint: This would be an unlikely scenario.
Expect to see the vast majority of right-of-use assets
amortized over the lease term by the lessee.

Answer 424

A

The bargain purchase option is accounted for in a
manner similar to a guaranteed residual value.
The present value of the bargain purchase option is
included in the lease liability.

Answer 425

A

If the cost is an initial direct cost, then it is included
in the right-of-use asset amount and amortized over
the life of the lease. An initial direct cost does not
add to the lease liability. An example of an initial
direct cost is a document preparation fee associated
with a lease that has been executed.

Answer 426

A

Because the amount of the variable lease payments
and the fluctuation in the payment are unknown, the
lessee will expense the variable amount in the
period incurred.

Answer 427

A

$15,000

Louie will amortize the asset over the shorter of the lease term or useful life. In this question, the lease term is shorter at three years. The right-of-use asset divided by the three-year lease term results in $15,000 amortization expense each year ($45,000 / 3-year lease term).

Answer 428

A

The lessor will retain the asset on its books and record depreciation expense over the asset’s useful life.

Because the lease is an operating lease for the lessor, the lessor maintains the asset on its books and continues to depreciate it using an acceptable depreciation method.

Answer 429

A

Include the initial direct cost at its cost in the calculation of the right-of-use asset.

A cost that qualifies as an initial direct cost will be included in the lessee’s calculation of the right-of-use asset at its costs because these costs occur around the time of execution of the lease. Because the costs are included in the right-of-use asset amount, they are effectively amortized over the lease term as the right-of-use asset is amortized.

Answer 430

A

Include the bargain purchase option at its present value using a single-sum present value factor in the calculation of the lease liability at the inception of the lease.

The lessee treats a bargain purchase option as an expected one-time (or single) payment occurring at the end of the lease. The lessee applies the present value factor to the bargain purchase option amount and includes that amount in the lease liability at the inception of the lease.

Answer 431

A

A credit to sales revenue for the fair value of the asset less the present value of the unguaranteed residual value.

The lessor will subtract the present value of the unguaranteed residual value from both the cost of goods sold (debit) and the sales revenue (credit).

Answer 432

A

Hospitals and other health care entities
Colleges and universities
Voluntary health and welfare organizations
Other not-for-profit organizations

Answer 433

A

The Financial Accounting Standards Board (FASB)

Answer 434

A

Charity raising money for underprivileged children

Nursing home, Clinic, Hospital are all health care organizations.

Answer 435

A

FASB standards.

The Financial Accounting Standards Board (FASB) sets accounting standards for not-for-profit and for-profit organizations.

Answer 436

A

An economic resources measurement focus.

Nongovernmental not-for-profit organizations use full accrual accounting and the flow of economic resources measurement focus.

Answer 437

A

Governmental Accounting Standards Board (GASB).

A museum that receives the majority of its funding from property taxes is most likely a part of a city government and will be subject to accounting and reporting standards established by the Governmental Accounting Standards Board (GASB).

Answer 438

A

Statement of financial position
Statement of activity (operations)
Statement of cash flows

Answer 439

A

Net assets without a donor restriction

2. Net assets with a donor restriction

Answer 440

A

Program services

2. Supporting services

Answer 441

A

Management and general

2. Fund raising

Answer 442

A

Net assets without a donor restriction. Expenses are
not recognized in the net assets with a donor
restriction category.

Answer 443

A

Time restrictions, when the donor stipulates
that the resources must be spent in a certain
time period
Purpose restrictions, when the donor
stipulates that the resources must be spent on
a specific manner

Answer 444

A

The entry is a reclassification. “Net assets released
from restrictions” is reported as a $5,000 decrease in
the revenue section of net assets with a donor
restriction and as a $5,000 increase in the revenue
section of net assets without a donor restriction.

Answer 445

A

There are three options: on the face of its statement
of operations, as a schedule in the notes to the
financial statements, or as a separate financial
statement. Note that prior to ASU 2016–14, only
Voluntary Health and Welfare Organizations (VHWO)
were required to report functional expenses. Now all
NFP organizations are required to include this
information.

Answer 446

A

Fundraising costs.

Support activities include general administration and fundraising expenses. The nurses’ mileage cost, employee benefits, and supplies are expenses necessary to visit the elderly that further the mission of the organization and are classified as a part of “program services” in the statement of functional expenses.

Answer 447

A

The statement of activities.

The statement of activities is the operating statement for all not-for-profit organizations, which includes voluntary health and welfare organizations.

Answer 448

A

Residual interest.

Not-for-profit organizations do not have owners and, therefore, the difference (residual) between assets and liabilities is referred to as “net assets.”

Answer 449

A

Row A

Revenues are membership dues, dividend income, and interest income for a total of $16,000. Public support consists of cash gifts and donated supplies for a total of $42,000.

Answer 450

A

Statement of financial position, statement of activities, and a statement of cash flows

FASB ASC 958 requires a statement of financial position, a statement of activities, and a statement of cash flows for private, not-for-profit organizations. Moreover, all not-for-profit organizations must report expenses by nature and function in one place: on the face of the statement of activities, as a schedule in the notes to the financial statements, or as a separate financial statement.

Answer 451

A

Net assets without donor restriction, net assets with donor restriction, and total net assets.

FASB ASC 958–210–45–1, Not-for-Profit Entities, requires separate dollar amounts for net assets without donor restriction, net assets with donor restriction, and total net assets.

Answer 452

A

$210,000 from financing activities

The $200,000 cash contribution is a financing activity because it has been donor restricted for the long term. Related interest and dividends that are donor restricted for long-term purposes are also shown as cash receipts from financing activities.

Answer 453

A

Total changes in net assets.

Under the indirect method, the cash flow statement would begin with total changes in net assets. Conversely, using the direct method, we begin with the cash flows from operating activities section. Please note that following ASU 2016–14, the reconciliation of direct method to the indirect method is no longer required for those using the direct method. (It was required prior to ASU 2016–14.)

Answer 454

A

Operating Activities.

Unrestricted cash contributions should be included in the Operating Activities section of the Statement of Cash Flows, along with unrestricted investment earnings, revenue restricted for operating purposes (Program Restrictions), revenue from exchange transactions, and operating expenditures (salaries, supplies, interest expense), including grants to other organizations

Investing Activities.
This section includes inflows and outflows from the sale of capital assets and investment assets.

Financing Activities.
This section includes contributions and investment revenues restricted for long-term purposes (e.g., restrictions for acquisition of capital assets, endowments) and debt-related activities (debt proceeds, repayments, lease payments, etc.)

Capital and Related Financing Activities.
The Statement of Cash Flows for not-for-profit organizations does not have a “Capital and Related Financing Activities” section (this section is found in the Statement of Cash Flows for governmental entity’s Proprietary Funds)

Answer 455

A

$70,000

Gains on the principal of an endowment, whether realized or unrealized, are normally not available for expenditure and are consequently not recognized as income. However, in this instance, the trust agreement stipulates that both the income and appreciation on the investment are to be used for support. Because of this, both the investment income of $50,000 and the net investment appreciation of $80,000 increase net assets with donor restriction; net assets with donor restriction would be decreased by the $60,000 spent to maintain the senior center.

The $700,000 endowment principal would have been recognized in the year of the donation as part of net assets with donor restriction. The remaining $70,000 increase in correctly reflects the changes for the period.

Answer 456

A

A freezer costing $150,000 for storing food for the soup kitchen

The freezer is classified as equipment and therefore must be depreciated.

Although the building will ultimately be depreciated, depreciation does not begin until the asset is completed. Construction in progress is not a depreciable asset.

Land is not a depreciable asset.

Linens, even when purchased in a large quantity such as this, are short-lived assets and expensed when placed into service.

Answer 457

A

In cash inflow from financing activities and cash outflow from investing activities

The structure of the Statement of Cash Flows for a not-for-profit organization is identical to that of a for-profit organization: debt proceeds are reported as cash inflows under financing activities, and purchases of capital assets are reported as cash outflows under investing activities.

Answer 458

A

Income statement

According to ASC 958–205–5–5, the Statement of Activities for not-for-profit organizations is the financial statement that is issued instead of a business entity’s income statement.

Answer 459

A

Salaries of fund-raisers for funds used in research

The Statement of Functional Expenses requires that expenses be reported by functional classification as either (a) program related or (b) support service related. Support expenses include management, general administrative, and fund-raising expenses required to operate. Program expenses are directly related to the program or mission of the organization. The salaries of researchers, cost of equipment used in research, and cost of laboratory supplies used in research are all examples of program expenses. The salaries of fund-raisers for funds used in research are support expenses because their efforts are not directly related to conducting the research itself.

Answer 460

A

Part of supporting services.

Expenses for not-for-profit organizations fall into two broad categories:

(1) program services and (2) supporting services. Expenses for program services are incurred because of the stated mission of the not-for-profit. All other expenses fall under the supporting services classification. The $5,000 in management and general expenses should be reported as part of supporting services.

Answer 461

A

In general, contributions are recognized as revenue
in the period when the contribution is made,
regardless of whether they are received in cash or
not.

Answer 462

A

DR: Pledges Receivable $100,000
CR: Est. Uncollectible Pledges $20,000
CR: Contribution (Revenue) $80,000

Answer 463

A

Fair market value at the date of donation

Answer 464

A

Held for public exhibition, education, or
research rather than financial gain

Protected, kept unencumbered, cared for, and
preserved

Subject to a policy that requires proceeds from
sales of collection items to be used to acquire
other items for collections

Answer 465

A

It is recognized if the services require special skills,
the person providing the services possess those
skills, and the services would have been purchased if
not obtained by donation.

Answer 466

A

Unconditional
Voluntarily made
Nonreciprocal
Not made by an owner

Answer 467

A

They are recognized when the conditions are
substantially met or the likelihood of the conditions
not being met is remote.

Answer 468

A

General fund
Special revenue funds
Capital project funds
Debt service funds
Permanent funds

Answer 469

A

Variance power. The not-for-profit (NFP) must have
the ability to set aside the donor restriction (e.g.,
redirect the resources to another beneficiary or
revoke the restriction). The NFP would recognize a
liability if it does not have variance power.

Answer 470

A

When the pledge conditions are met.

Contribution revenue is recognized when the following characteristics occur: a “condition” does not exist or has been met, it is not part of an exchange transaction, it is made voluntarily, and it does not involve an ownership interest. This answer is correct because the pledge condition (perhaps a condition to “match” the pledge) has been met.

Contribution revenue recognition is not tied to the timing of cash collections.

Answer 471

A

Increase $300,000.

The $300,000 in bookstore revenue increased net assets without a donor restriction by $300,000. The $100,000 spent came from a net assets with a donor restriction. The $100,000 expense (decrease) and $100,000 amount “released” from donor restriction (increase) will appear in the net asset without a donor restriction section.

Answer 472

A

Row A

Because the restriction is an internal, not an external, restriction, the classification of net assets without a donor restriction does not change.

Answer 473

A

Decrease in net assets with a donor restriction and increase in net assets without a donor restriction.

Net assets released from restrictions would cause a decrease in net assets with a donor restriction and an increase in net assets without a donor restriction.

Answer 474

A

$250,000

Because the $250,000 cannot be spent until 20X4, a time restriction applies, and the contribution would be classified as net assets with a donor restriction in the 20X3 financial statements. The $200,000 contribution is not restricted and would be reported as contributions without a donor restriction.

Answer 475

A

Contributions with a donor restriction.

Since the donation was not spent in the current year, it should be considered a contribution with a donor restriction. When the equipment is purchased in 20X2, the amount will be “released” from donor restriction as an increase in net assets without a donor restriction and a matching decrease amount in net assets with a donor restriction.

Answer 476

A

Liability.

The contribution received was a donation to be delivered to another beneficiary. Amer is the intermediary; therefore, the cash contribution is recorded as a liability at year-end.

Answer 477

A

$2,500

Because Ame received tickets in connection with its contribution to Oz , the transaction must be treated partly as an exchange transaction and partly as a contribution. Oz must recognize Revenue equivalent to the value of the goods or services provided to Ame (25 tickets × $100 = $2,500). Oz and Ame must each deduct the value of the goods or services exchanged from the total amount received/contributed to arrive at the amount to be recognized as a charitable contribution ($50,000 − $2,500 = $47,500).

Journal Entry:

Cash 50,000
Ticket Sales Revenue 2,500
Contributions Revenue 47,500

Answer 478

A

As a net asset with a donor restriction

Since the resources must be retained for 20 years, they must be reported under a restricted classification of net assets. However, because they are not permanently restricted but may ultimately be expended, they should be recorded as a temporarily restricted asset rather than a permanently restricted asset.

Answer 479

A

An art collector donated a famous oil painting to a local nongovernmental art museum for display in its exhibit hall.

Collections (i.e., inexhaustible fixed assets) donated to a not-for-profit organization do not need to be capitalized. Three conditions must be met: (1) the asset is held for public exhibition, education, or research rather than financial gain; (2) the asset must be protected, unencumbered, cared for, and preserved; and (3) the asset is subject to a policy that requires proceeds from sales of collection items to be used to acquire other items for the collection. Only the famous painting donated for display appears to meet these three conditions.

Answer 480

A

It should be included as a decrease in net assets without a donor restriction.

It should be included as a decrease in net assets without a donor restriction. ASC 958-360-35 requires depreciation of capital assets by not-for-profit organizations. Depreciation expense is allocated to programs and therefore is a decrease in net assets without a donor restriction. The answer that depreciation is not included is incorrect because ASC 958-360-35 requires depreciation. The other two answers are incorrect choices that are based on the option, which was eliminated by ASU 2016-14, for a not-for-profit organization to adopt a policy of an implied time restriction on gifts of long-term assets.

Answer 481

A

Report as income in Year 1.

The contribution has a time restriction and will be recognized contribution revenue in the net assets with a donor restriction category for Year 1. When the time restriction is met in Year 2, the amount will be recorded as a decrease in net assets with a donor restriction and as an increase in net assets without a donor restriction—essentially a reclassification of net assets.

Answer 482

A

$0

The $100,000 endowed is recognized as contribution revenue in the net asset with a donor restriction category. The $8,000 current-year earnings on the endowment are recognized in the net asset with a donor restriction category because there is a purpose (use) restriction. As expenses related to the care for older horses occur, an amount equal to those expenses will be reclassified (i.e., “released”) from net assets with a donor restriction to net assets without a donor restriction to offset the expenses.

Answer 483

A

$2,050,000 increase

The $2,000,000 gift is permanently invested and will be reported as part of net assets with a donor restriction. The income is dedicated to a specific program starting in Year 2. Therefore, in Year 1 all the income and the change in fair value of the investment are restricted by the donor as to time, so $50,000 is also classified as net assets with a donor restriction in the first year. In Year 2, the $50,000 will be reclassified from net assets with a donor restriction to net assets without a donor restriction.

Answer 484

A

$ 66,240

The $20,000 received on January 1 is a contribution in that year and is an increase in net assets without a donor restriction. The pledge in the next four years is a net asset with a donor restriction as to time and is recognized at the net present value ($20,000 × 3.312 = $66,240).

Answer 485

A

Net assets with a donor restriction, net assets without a donor restriction, and total net assets

ASC 958-201-45-1 requires three categories of net assets: (1) net assets with donor restrictions, (2) net assets without donor restrictions, and (3) total net assets (i.e., 1 plus 2). This is a major change found in ASU 2016-14, which replaced the three categories of net assets previously used (permanently, temporarily, and unrestricted net assets). which is the answer given here.

Answer 486

A

Be reported as an increase in both expenses and contributions.

ASC 958-605-25-16 requires nongovernmental not-for-profits to account for contributions received at fair value as revenues or gains, assets, decreases in liabilities, or expenses. When the contribution takes the form of donated services, it can only be recognized if the services donated require specialized skills, are provided by individuals possessing those skills, and would have been purchased if not donated.

In the case at hand, the broken windows were replaced by a professional glazier (a person who sets glass). If the glazier had not donated his services, then Lea Mediators would have hired someone to replace the broken windows. The conditions for recognizing the donated services as a contribution have been met. Lea would make the following entry, which would be reflected in the Statement of Activities.

Expenses xxx
Revenues - Contributions xxx

Answer 487

A

Gifts and bequests from third parties that are to be
retained and invested for a period of time or until a
specific event occurs, but after the criterion has been
met, the full amount can be spent.

Answer 488

A

Revenues and direct costs are reported at gross
amounts. Expenses to promote the event, such as
printing and mailing, are treated as fund-raising and
are not charged against the special event.

Answer 489

A

An endowment is underwater when its fair value is
less than the original gift or a level set by the donor
or by law. The amount underwater is disclosed in the
net assets with a donor restriction of the statement
of financial position.

Answer 490

A

When they are placed in service. Note: ASU 2016-14
removed the option for not-for-profits to have a
policy to “imply” a time restriction on donated longterm assets.

Answer 491

A

Row B

Both endowments are part of net assets with donor restriction. The term endowment allows a portion of the principal to be spend each period. The regular endowment does not allow any of the principal to be spent. Following ASU 2016-14, both endowments are donor-restricted net assets when the contributions were made.

Answer 492

A

Net assets with donor restriction

This is an example of a use restriction for which the gift will be recognized as an increase in net assets with donor restriction at the time of the gift.

Answer 493

A

Fair value at the date of the gift.

Donated securities are reported at fair value at the time of donation.

Answer 494

A

Fair value.

According to ASC 958-320-35-1, not-for-profit organizations report their investment in debt securities and equity securities at fair value.

Answer 495

A

$14,000

ASC 958-650-30-2 requires donated securities to be initially recorded at their fair value on the date of the gift and to be reported at their market value at the financial reporting date (at the end of the year).

Answer 496

A

Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of activities as increases or decreases in net assets without donor restriction.

If the donor placed restrictions on the use of gains (purpose or time restrictions), the gains are temporarily restricted until the restriction is met. If there are no restrictions, the gains and losses are unrestricted. Revenues and expenses that must be reported should be reported separately but gains and losses may be reported net.

Answer 497

A

Quoted market prices

Unlike for-profit entities, not-for-profit entities do not break debt securities into trading, available-for-sale, and held-to-maturity categories. Following ASC 958-320-35-1, not-for-profits value debt securities at fair value (quoted market price).

Answer 498

A

Payments made to health care providers for
comprehensive client coverage provided for a fixed
fee (e.g., health maintenance organizations).

Answer 499

A

Net assets without a donor restriction

Net assets with a donor restriction

Answer 500

A

It is not recognized (not as revenues, receivable, or
bad debt in the financial statements of a not-forprofit hospital). Charity care is reported in the notes
to the financial statements, however.

Answer 501

A

Balance sheet
Statement of operations
Statement of cash flows

Answer 502

A

Balance sheet
Statement of revenues, expenses, and changes
in net position
Statement of cash flows

Answer 503

A

Cash flows from noncapital financing activities and
cash flows from capital and related financing
activities are required sections of the cash flow
statement for governmental health care agencies.
Not-for-profit healthcare agencies report cash flows
from financing activities (a single category).

Answer 504

A

Contractual adjustments are a contra account
deducted from patient service revenues in deriving
net patient service revenues, which is the first line in
the statement of operations for a healthcare
organization.

Answer 505

A

$280,000

All three items are peripheral in nature and should be included in nonoperating revenues and gains.

Answer 506

A

Statement of changes in fund balance

Hospitals are required to issue a statement of financial position, a statement of activities, and a statement of cash flows.

Answer 507

A

Row D

All healthcare organizations are required to recognize depreciation expense.

Answer 508

A

Row B

Governmental healthcare organizations follow GASB statements.

Answer 509

A

$880,000

Gross patient service revenue ($1,000,000) less the allowance for discounts to hospital employees ($20,000) and less contractual adjustments ($100,000) equals net patient service revenue of $880,000. FASB ASC 954-605-45-4 requires the financial statement presentation of the provision for bad debts associated with patient service revenue. A provision for bad debts must be presented on a separate line as a deduction from net patient service revenue; that is, as a contra–revenue account rather than as an expense. Moreover, the healthcare entity must disclose net patient revenues for each major payor source (e.g., third-party payor and self-pay). Bad debt expense related to receivables other than patient service revenue continues to be presented as an operating expense, which is the case for this situation.

Answer 510

A

$460,000

Total revenues, gains, and other support on the Statement of Operations includes net patient revenue, premium revenues (e.g., HMO capitation fees), other revenue, and net assets released from restrictions for operating purposes. Net patient revenues are fees for patient services less contractual adjustments and charity care. Both governmental and not-for-profit hospitals record estimates for uncollectible patient accounts as contra-revenue accounts. The correct answer is $460,000: $500,000 (net patient revenues including charity care) less $100,000 (charity care), less $70,000 uncollectible patient accounts, plus $50,000 (net assets released for operating activities) plus $80,000 (other revenue). Take note that uncollectible accounts other than patient accounts are recorded as bad debt expense by not-for-profit hospitals (ASC 954-605-56-6) and that governmental hospitals will not report bad debt expense since they use a net revenue approach. Moreover, had the net assets released from restrictions not been for operating purposes; such as to acquire fixed assets, the reclassification of net assets released would not be included in total revenues, gains, and other support section. Rather, the amount would appear after the excess (deficiency) of revenues, gains, and other support over expenses and losses (e.g., the performance indicator) near the bottom of the unrestricted net asset section of the Statement of Operations.

Answer 511

A

Nonoperating Revenue $11,000

Both the $7,000 of unrestricted gifts and the $4,000 of unrestricted bequests should be credited to Nonoperating Revenue.

Answer 512

A

Other Revenues.

Government-affiliated hospitals normally have three broad categories of revenues:

Patient Service Revenues
Premium Fees
Other Revenues. Within the Other Revenues category is a variety of different activities including proceeds from the sale of cafeteria meals.

Answer 513

A

Revenues from educational programs - Yes
Unrestricted gifts - No

Government hospitals classify revenues into three broad categories: Patient Service Revenues, Premium Fees, and Other Revenues. The Other Revenues category includes revenues generated by ongoing activities of the hospital other than patient care. Revenues from educational programs are included in this category.

Government hospitals record unrestricted gifts as Nonoperating Gains in the General Fund.

If we assume that the hospital is not a government entity, then it must conform with ASC 954-225-45. The revenues from educational programs would still be classified as Other Operating Revenues. The unrestricted gifts would be classified as Revenues from Contributions.

Answer 514

A

Other operating revenue of $5,000.

Medicine is considered essential to the major ongoing operation of the hospital, therefore the donation of medicine is recorded as other operating revenue at its fair value.

dr. Inventory of Medicine
cr. Donated Revenues

ASC 958-605-30-9

Answer 515

A

Both I and II.

Both room and board fees from patients and recovery room fees are normal, ongoing activities of a not-for-profit hospital.

Answer 516

A

Activities carried on by an educational institution
that are not directly related to the delivery of
instruction (i.e., residence halls, dining services,
athletics)

Answer 517

A

It is reported net of tuition discounts and scholarship
allowances in the operating statement. However,
scholarships, assistantships, and tuition waivers
granted in return for services are reported as
expenses

Answer 518

A

Unrestricted
Restricted
Net investment in capital assets

Answer 519

A

Net assets without a donor restriction

2. Net assets with a donor restriction

Answer 520

A

$257,000

Tuition revenue is always reported net of scholarships and financial aid. Thus, the net tuition revenue is shown as $190,000. Because the gift is designated by the donor, the $100,000 is initially reported as an increase in net assets with a donor restriction. When $67,000 is properly spent, that amount is reclassified from net assets with a donor restriction to net assets without a donor restriction. Thus, the total increase is $190,000 plus $67,000, or $257,000.

Answer 521

A

Must be depreciated.

Capital assets must be depreciated by both private and public colleges.

Answer 522

A

Row A

FASB ASC 958 requires that the assets be reported at fair value.

Answer 523

A

The principal mission of not-for-profits is to
provide goods and services.

Primary resources are obtained through
nonexchange transactions.

There are restrictions on resources.

There are no individual ownership interests.

Answer 524

A

The Government Accounting Standards Board

GASB

Answer 525

A

FASB

The Financial Accounting Standards Board (FASB) is the highest level of GAAP for all nongovernmental entities, which includes nongovernmental not-for-profit organizations.

GASB is the highest level of authority in GAAP for governmental entities.

FASAB is the highest level of authority in GAAP for federal government agencies.

Answer 526

A

A software company that sells educational software exclusively to public elementary schools

A vendor who specializes in offering goods and/or services exclusively to a governmental or not-for-profit organization is not considered a governmental or not-for-profit entity.

A public independent school district is a governmental organization.

A private foundation organized for charitable purposes is a form of not-for-profit organization.

Religious organizations, including churches, are a form of not-for-profit organization.

Answer 527

A

Proceeds from taxation

One of the unique characteristics of government is its power to force involuntary financial resource contributions through taxation. No other form of organization has this power.

Most organizations have the ability to charge for services.

Grant proceeds are important sources of financial reports for governments and not-for-profit organizations.

Most types of organizations have the ability to offer bonds.

Answer 528

A

Governmental Accounting Standards Board (GASB).

The Governmental Accounting Standards Board (GASB) was established in 1984 to promulgate standards of financial accounting and reporting for the activities and transactions of state and local governments. The GASB’s authority includes determining the measurement focus and basis of accounting standards for governmental fund operating statements.

The National Council on Governmental Accounting (NCGA) was the predecessor standard setting body to the GASB.

The Government Accounting and Auditing Committee of the AICPA (GAAC) is not an active committee of the AICPA.

The Financial Accounting Standards Board (FASB) is the primary standard setting body for businesses and not-for-profit organizations.

Answer 529

A

Timeliness
Relevance
Understandability
Comparability
Consistency
Reliability

Answer 530

A

Advocate groups within the state.

Advocate groups are part of one of three categories of primary users of government financial reports as identified by GASB Concept Statement No. 1: the citizenry (to which the government is accountable to), legislative and oversight bodies (who represent the citizenry), and investors and creditors (those who lend or participate in the lending process). The citizenry group includes citizens, the media, advocate groups, and public finance researchers.

Answer 531

A

Supplemental information

GASB Concepts Statement No. 3, basic financial statements, the accompanying notes to the basic financial statements, and required supplemental information are essential information and therefore required in general purpose external financial reporting. Supplemental information is useful but not required. Service efforts and accomplishment information are classified as supplemental information and are therefore voluntarily reported.

Answer 532

A

To demonstrate that the budget is prepared on the GAAP basis

GASB Concepts Statement No. 1 lists the following four financial reporting implications associated with the legally adopted annual budget: (1) expression of public policy, (2) expression of financial intent, (3) form of control, and (4) it may provide a basis for evaluating performance (if the government established service efforts and accomplishment goals as part of its budget process). Since budgets are usually prepared according to requirements of state and local laws, the budget is not required to be prepared on the GAAP basis. Many state and local governments prepare the budget on the cash basis. When this occurs, the budget-to-actual statement is presented on the budget basis (i.e., cash basis) and a reconciliation of the cash basis to the GAAP basis is included in the notes to the basic financial statements.

Answer 533

A

Internal managers.

GASB Concepts Statement No. 1 defines the primary users of the general purpose external financial report as the citizenry (e.g., taxpayers), legislative and oversight bodies (e.g., school boards), and investors and creditors (e.g., bond insurers). Typically, internal managers who have access to information through internal reporting are not considered primary users.

Answer 534

A

Outcome.

The example in the question is an outcome measure. Outcome measures indicate the accomplishments or results that occur because of the services provided.

Measures of effort are the amount (quantity) of financial and nonfinancial resources that are applied to a service. Example: the amount of salaries paid to firefighters.

Measures of output are the quantity of service provided. Example: the number of fire calls responded to by firefighters.

Efficiency measures related efforts to the output of services. Example: the cost per fire call answered.

Answer 535

A

Accountability.

GASB Concept Statement No. 1 defines two paramount objectives for financial reporting in government: (1) Accountability and (2) interperiod equity. Therefore, “Accountabilty” is the correct answer to this question. Concept Statement No. 1 describes six characteristics of effective financial reporting: (1) understandability, (2) reliability, (3) relevance, (4) timeliness, (5) consistency, and (6) comparability (TRUCCR).

Answer 536

A

Fundamental to public administration - Yes
Component of accountability - Yes

GASB Concepts Statement No. 1 states that interperiod equity is a basic component of accountability and fundamental to public administration.

Answer 537

A

I only

The adoption of a balanced budget supports interperiod equity because it is an attempt to ensure that the current generation of citizens does not shift the burden of paying for current-year services to future-years’ taxpayers (GASB Concepts Statement 1).

Residual equity transfers are nonrecurring or nonroutine transfers of equity between funds (GASB Codification 1800.102). These transfers occur within one accounting period and do not support interperiod equity as an objective of financial reporting.

Answer 538

A

Property tax revenue for an amount deferred because it was not available

Property tax revenue that is not currently available is not reported at the governmental fund level but is reported in the government-wide statements—this is a very common reconciliation item between governmental fund balance and government-wide net position.

This question focuses on the difference between governmental activities in government-wide financial statements that are prepared on the accrual basis of accounting and governmental fund-level financial statements that are prepared on the modified accrual basis of accounting. Salaries payable at the beginning of the next year (i.e., within 60 days in the next year) are considered to be paid from “currently available resources” and therefore will be recognized as liabilities in the current year by both government-wide and fund-level financial statements.

Grant monies received and spent on repairs in the same year will be accounted for similarly in the government-wide and fund-level financial statements.

Transfers between governmental funds are eliminated in deriving the government-wide financial statements; hence this answer is not correct. (Note that transfers between governmental funds and enterprise funds are reclassified as “internal balances” in the government-wide statement of net position.) Property tax revenue that is not currently available is not reported at the governmental fund level but is reported in the government-wide statements—this is a very common reconciliation item between governmental fund balance and government-wide net position.

Answer 539

A

Pension trust funds
Private-purpose trust funds
Investment trust funds
Agency funds

Answer 540

A

Enterprise funds

2. Internal service funds

Answer 541

A

Governmental funds
Proprietary funds
Fiduciary funds

Answer 542

A

A fiscal entity

An accounting entity (i.e., debits = credits)

Answer 543

A

The enterprise fund. Enterprise funds provide the
majority of their services to external users for a fee.
In contrast, an internal service fund is used to
account for business-type activities that provide
services to other departments within the
government.

Answer 544

A

General fund
Special revenue funds
Capital project funds
Debt service funds
Permanent funds

Answer 545

A

Segregated for the purpose of carrying on specific activities or attaining certain objectives.

Fund accounting is used to segregate resources for accounting purposes. The resources do not have to be physically segregated.

Governmental accounting systems are organized and operated on a fund basis. A fund is a fiscal and accounting entity with a self-balancing set of accounts that record cash and other financial resources, along with the related liabilities and residual equities or balances, which are segregated for the purpose of carrying on specific activities or attaining certain objectives. GASB Codification 1100.102

Answer 546

A

Wastewater and sewerage services

Wastewater and sewerage services are usually provided on a service-fee basis; therefore, they are accounted for in an enterprise fund - one of the two types of proprietary funds. Enterprise funds are also referred to as “business type” funds and use full accrual accounting.

Police protection is usually financed by the general revenues of the government and accounted for in the general fund.

The tax assessor office is part of the general government and usually accounted for in the general fund.

Routine street, curb, and sidewalk maintenance and repairs are usually accounted for in either the general fund, when financed by general revenues, or in a special revenue fund, when financed by resources dedicated for that purpose (e.g., a half-cent sales tax approved by the voters for street repairs).

Answer 547

A

Motor pool fund

A motor pool fund is a type of internal service fund that charges other parts of the government for services provided on a cost-reimbursement basis. An internal service fund is one of the two types of proprietary service funds. Recall the mnemonic “PIPPA” for fiduciary funds - pension trust funds, investment trust funds, private-purpose trust funds, and agency funds.

A county and city tax collection fund is an agency fund administered to collect and distribute property taxes collected to the county and the city.

A historical society private-purpose trust fund is a fiduciary fund.

A police and fire pension trust fund is a fiduciary fund.

Answer 548

A

Enterprise.

An Enterprise Fund is commonly used in situations where user fees are the primarily source of revenue and the fee charged is based on an amount sufficient to cover the costs of operations and to provide for capital maintenance, which is the case here. Note that the fee for a service provided and that most of the users are external to the government.

Answer 549

A

Enterprise.

Recall the acronym “DRIP-CEG-PIPPA” where the vowels in “DRIP-CEG” represent fund types that use accrual accounting and the consonants use modified accrual accounting. The “I” stands for Internal Service Fund and “E” for Enterprise Funds. This answer is correct.

Special Revenue Fund, is a governmental fund type that uses the modified accrual basis of accounting.

Capital Projects Fund, is a governmental fund type that uses the modified accrual basis of accounting.

Debt Service Fund, is a governmental fund type that uses the modified accrual basis of accounting.

Answer 550

A

Separate legal entity

A fund is both a fiscal and an accounting entity. A fund is “fiscal” because it has assets, liabilities, revenue, expenditure or expense, and fund balance or other equity accounts. A fund is “accounting” because it has its own ledgers and contains a self-balancing set of accounts. A fund is not a separate legal entity.

Answer 551

A

Often are not expected to contribute to the generation of revenues.

General fixed assets are items on which financial resources have been expended and accountability must be maintained; however, their main purpose is NOT the generation of revenues.

General fixed assets used for government activities need to be maintained at the same level as those of businesses so that the government can continue to provide the citizenry with an adequate level of service. Although these assets are used to provide services to the citizenry, they are NOT expected to contribute to the generation of revenues. The fixed assets of proprietary funds are expected to contribute the generation of resources.

Answer 552

A

Private-purpose trust.

Recall the acronym “PIPPA” for fiduciary funds. Fiduciary funds include the following 4 types of funds: P ension trust funds, I nvestment trust funds, P rivate- P urpose trust funds, and A gency funds.

Internal Service Fund is a Proprietary Fund Type.

Permanent Fund is a Governmental Fund Type.

Special Revenue Fund is a Governmental Fund Type.

Answer 553

A

Agency.

Seaview City is merely acting as an agent for the state and should use an agency fund to receive and then distribute the funds as directed by the state.

If Seaview had administrative or direct financial involvement in the summer camp program, then it would recognize revenue for the receipt of the grant and related expenditure or expense in a governmental fund, private-purpose trust fund, or proprietary fund depending on the specifics of the program.

Answer 554

A

Accrual accounting: Flow of economic resources

Answer 555

A

Modified accrual: Flow of current expendable

financial resources

Answer 556

A

Measurable

Available

Answer 557

A

$900,000

On the Statement of Revenues, Expenditures, and Changes in Fund Balances, which reports transactions using the modified accrual basis of accounting, repayment of principal on long-term debt, payments to vendors, and purchases of fixed assets are all reported as expenditures.

Answer 558

A

Expenditure.

Governmental fund types use the modified accrual basis of accounting which focuses on the “flow of financial resources.” Consequently, the use of financial resources is an expenditure rather than an expense without regard to the character of the expenditure (e.g., operating expense or capital expense). Therefore, as this answer states, the new police car (a long-term asset) is recorded as an expenditure in the period of acquisition because it represents an outflow of financial resources. Since it is an immediate expenditure, the General Fund does not list the car as a noncurrent asset. However, in the government-wide Statement of Net Position (not part of this question) the car would be included in the noncurrent assets and depreciated overtime.

Answer 559

A

Row D

Todd City should recognize the grants as revenues in the accounting period when they are susceptible to accrual. For grants, the expenditure of resources is a prime factor in determining eligibility for accrual. All of the operating grant has been spent; therefore, 100% should be recognized as revenue.

Since only 90% of the capital grant has been spent, only 90% can be recognized as revenue.

Answer 560

A

Been credited.

The Expenditures control account is a temporary account that must be closed at the end of the fiscal year. The Expenditures control account is debited as resources are expended during the year. When the books are closed at the end of the year, this account should be CREDITED for $9,000,000 so that the balance in the account is zero.

Answer 561

A

Expenditures

The expenditures account is a temporary account that is closed at the end of the fiscal year. Expenditures occur within a given fiscal period and are not carried over into a new fiscal period.

Answer 562

A

Row A

The general fund uses the modified accrual basis of accounting. Under this basis, revenues are recognized in the accounting period when they become available and measurable.

An enterprise fund uses the accrual basis of accounting. Under this basis, revenues are recognized in the period in which they are earned and measurable.

Answer 563

A

Special revenue funds

All governmental funds, including special revenue funds, use the modified accrual basis of accounting.

All proprietary funds, including enterprise funds, use the accrual basis of accounting.

Answer 564

A

Income determination.

Proprietary funds account for activities of the governmental unit that are similar to activities conducted by commercial enterprises. The orientation of accounting and reporting for proprietary funds is similar to that used in private businesses. The accrual basis of accounting is used, and the measurement focus is on income determination, financial position, and cash flow (GASB Codification 1300.102).

Program is an expenditure classification, not an orientation of accounting and reporting for proprietary funds.

Flow of funds is the focus for governmental type funds.

Proprietary funds do NOT have a project orientation.

Answer 565

A

Flows and balances of financial resources

he primary measurement focus for governmental fund types is on the flows and balances of financial resources (GASB Codification 1300.102).

Capital maintenance is not the primary measurement focus of governmental fund types because general fixed assets are not accounted for in these types of funds. General fixed assets are recorded in the General Fixed Asset Account Group.

Cash is just one example of financial resources.

Income determination is not the primary measurement focus of governmental funds because there is no profit motive associated with these types of funds.

Answer 566

A

Modified accrual basis of accounting.

Because the measurement focus basis for governmental funds is the flow of current financial resources, the modified accrual basis of accounting is used to prepare governmental fund financial statements.

Answer 567

A

An amount to be paid from current financial resources

The general fund uses the modified accrual basis of accounting, and liabilities are recognized for those amounts that are to be paid from current financial resources, essentially, related to goods and services of the current year. Recall that according to the 60-day rule, “current financial resources” includes the amount the government receives in the first 60 days of the next fiscal year.

60-day rule on determining current financial resources.

An amount set aside to pay for an unfilled contract is probably a board-designated amount that would be classified as either committed fund balance or assigned fund balance but not as a liability. This topic is covered in the lesson “Net Position and Fund Balance.”

Answer 568

A

Modified accrual basis

Answer 569

A

It is a debit

Answer 570

A

This is a credit.

Answer 571

A

The appropriations account

Answer 572

A

It is a debit.

Answer 573

A

It is a credit

Answer 574

A

DR: Appropriations
CR: Estimated Revenues
DR or CR* Budgetary Fund
*As required to balance the entry.

Answer 575

A

DR: Estimated Revenues
CR: Appropriations
DR or CR* Budgetary Fund
*As required to balance the entry

Answer 576

A

A credit to Appropriations.

Appropriations are credited so that a schedule to compare Appropriations (credits) to Expenditures (debits) results in reporting whether appropriations are under or over spent.

Estimated Revenues will be debited.

Encumbrance accounting is used to control expenditures and is not part of the budget.

While there may be an entry to Fund Balance, it may not be a credit entry. If planned resources exceed planned spending, Fund Balance will be credited (a budget surplus). If planned resources are less than planned spending, then Fund Balance will be debited (a budget deficit).

Answer 577

A

The actual amounts in the budgetary comparison schedule should be reported using the government’s budgetary basis.

Budgets are legally binding on government administrators and lead to the formal recording of the budget, on the basis in which the budget is based, into the ledgers of the General Fund, special revenue funds, and any other funds that are required by law to record a budget. Reporting is on the budget basis. When the budget basis is different from GAAP, a separate schedule is required to reconcile the actual amounts in the budget to the GAAP amounts shown in the statement of revenues, expenditures, and changes in fund balances.

Answer 578

A

Expenditure

Under modified accrual accounting, as used by governmental fund types, “expenditures” are the amount of resources used to acquire an asset or service and are recognized when an obligation that will be paid from current financial resources has been incurred.

Appropriations are authorized (estimated) spending according to the legally adopted budget

Encumbrances are estimated spending recorded when goods and services are ordered.

Estimated financing sources are estimated inflows of financial resources that do not meet the criteria for revenues and are recorded when the legally adopted budget is entered into the ledgers.

Answer 579

A

General Fund and major special revenue funds for which a budget is legally adopted

GASB requires budgetary comparisons for the General Fund and all major special revenue funds for which a budget is legally adopted.

GASB does not require all governmental funds with legally adopted budgets to report budgetary comparisons.

GASB also requires budgetary comparisons for major special revenue funds for which a budget is legally adopted.

Answer 580

A

Arise from interfund transfers out.

Expenditures are recorded when goods and services are received. Other Financing Uses is recorded when funds are transferred from one fund to another, such as when the General Fund transfers resources to the Debt Service Fund to make payments on bonds payable.

Expenditures and other financing uses both decrease fund balance when closed at year-end.

Expenditures and Other Financing Uses both decrease the available financial resources of a fund.

Expenditures and Other Financing Uses both have normal debit balances.

Answer 581

A

Appropriations exceed actual expenditures.

Assuming that both actual and budgetary transactions are closed to the fund balance, closing appropriations, a credit balance account, would increase the fund balance whereas closing expenditures, a debit balance account, would decrease the fund balance.

Since appropriations were greater than expenditures, the net effect would be to increase the fund balance.

Since expenditures were greater than appropriations, the net effect would be to decrease the fund balance.

Since estimated revenues were greater than appropriations, the net effect would be to decrease the fund balance.

Since actual revenues were less than estimated revenues, the net effect would be to decrease the fund balance.

Answer 582

A

$5,550,000

Transfers in from other funds are classified as “Other Financing Sources” and are not revenues. The other three amounts are classified as revenues and, for budget purposes, should be included in determining “estimated revenues.” The total is $5,550,000.

Answer 583

A

Appropriations.

The Appropriations Control account, a budgetary account, would be credited for the amount of the authorized spending limit.

The Encumbrances Control would be debited and Reserve for Encumbrances would be credited at the time a commitment is made to spend some of the resources that have been appropriated.

There is no such account as Reserved for appropriations in governmental accounting.

Answer 584

A

Estimated Revenues Control should be credited for $20,000,000.

When the budgetary accounts are closed at the end of the fiscal year, the estimated revenues control account will be credited for the amount for which it was debited when the budget was recorded, $20,000,000.

Answer 585

A

$2,100,000 credit balance.

Park would credit the budgetary fund balance for $2,100,000 when it makes the following entry to record the budget.

Dr. Estimated revenues $30,000,000
Cr. Appropriations $27,000,000
Cr. Estimated transfers to debt service fund$900,000
Cr. Budgetary fund balance $2,100,000

Answer 586

A

The encumbrances account

Answer 587

A

It is a debit.

Answer 588

A

$3,000

The amount of available appropriations is calculated as follows: Authorized appropriation amount from the budget less outstanding encumbrances and less expenditures. In this example, $10,000 – $2,000 – $5,000 = $3,000.

Answer 589

A

A.

Encumbrances are increased (debited) when goods are ordered and decreased (credited) when goods are received.

Answer 590

A

Encumbrances.

Encumbrances are used to maintain a record of purchase orders issued such as the order by the controller’s office for computers.

Answer 591

A

Increased.

The encumbrance is reversed and replaced with the actual expenditure amount, which is less than the encumbered amount.

How encumbrance accounting operates is not policy related.

The encumbrance is reversed and replaced with the actual expenditure amount.

Answer 592

A

Temporary accounts are closed at the end of the year.

Expenditures are closed out (credited).

Encumbrances are debited and budgetary fund balance is credited when supplies are ordered.

Appropriations, not Expenditures, are recorded when the budget is integrated into the ledgers.

Expenditures are closed out (credited).

Answer 593

A

Goods and services are received and the invoice is vouchered.

When goods and services are received, expenditures are recorded and a liability, vouchers payable, is recorded.

Budget amendments result in entries to the budgetary accounts (i.e., estimated revenues, appropriations, estimated other financing uses and sources, and budgetary fund balance).

The liability is reduced when invoices are paid.

Answer 594

A

Budgetary account.

Encumbrance accounting works in conjunction with Appropriations to control spending as authorized in the legally adopted budget.

Encumbrances outstanding at the end of the year that will be honored in the subsequent year are part of assigned or committed fund balance, depending on the level of authority by which the commitment was made.

A liability is recognized when goods and services are received, not when goods and services are ordered.

Answer 595

A

A.

Since the full order was received, the entire $5,000 encumbrance is reversed out and the actual $4,900 in expenditure is recorded.

Answer 596

A

Fund balance assigned in the general fund.

Encumbrances outstanding at year’s end represent outstanding purchase orders or unfilled contracts. The fund balance classification is either restricted, committed, or assigned depending on the level of authority behind the encumbrance. If the government intends to use the resources for specific purposes but it is not done by a constraint imposed by external parties or enabling legislation (i.e., restricted) or by formal action of the government’s highest decision making authority (i.e., committed) then a portion of the fund balance needs to be assigned for the outstanding encumbrances to indicate that a portion of the fund balance is not available for future appropriations.

Encumbrances do not represent a designation of the fund balance.

Encumbrances outstanding at year’s end do not represent a long-term liability; therefore, they should not be reported in the general long-term debt account group.

Outstanding encumbrances represent outstanding purchase orders or unfilled contracts. Since the goods or services have not been provided, the encumbrances do NOT represent a liability to the general fund.

Answer 597

A

Assigned or committed fund balance.

The fund balance classification is either restricted, committed, or assigned depending on the level of authority behind the encumbrance. If the government intends to use the resources the specific purposes but is not a constraint imposed by external parties or enabling legislation (i.e., restricted) or by formal action of the government’s highest decision making authority (i.e., committed). Assigned fund balances should be used to indicate that a portion of the fund balance is not available for expenditure. The use of assigned or committed indicates that a portion of the fund balance has been segregated for expenditure on vendor performance.

Answer 598

A

Enterprise.

Encumbrance accounting is used for budgetary control and, therefore, is commonly used in Governmental Fund types, including the General, Special Revenue, and Capital Projects Funds. It is usually not used by Debt Service Funds since the terms of the debt control spending. It is rarely used by Proprietary Funds so the Enterprise Fund (answer D) is the best choice for this question.

Answer 599

A

The deferred inflow of resources

Answer 600

A

DR: Property Taxes Receivable
CR: Est. Uncollectible Property Taxes
CR: Deferred Inflow of Resources

Answer 601

A

Revenue is recognized when the eligibility
requirements are met. (Until then, a liability is
recognized).

Answer 602

A

Revenue is recognized when the stated time has
arrived or the stated event has occurred. (Until then,
deferred inflow of resources is recognized.)

Answer 603

A

Deferred inflows of resources

A deferred inflow of resources is the acquisition of net assets by the government that applies to a future reporting period, such as grant monies that are restricted to future periods. Consequently, the grant proceeds are recorded as an asset and a like amount is recorded as a deferred inflow of resources.

Revenues increase fund balance.

Other financing uses, such as operating transfers out, decrease fund balance.

A deferred inflow of resources is the acquisition of net assets by the government that applies to a future reporting period, such as grant monies that are restricted to future periods. Consequently, the grant proceeds are recorded as an asset and a like amount is recorded as a deferred inflow of resources.

Answer 604

A

A credit to Deferred Inflow of Resources—Grant Proceeds in the amount of $450,000.

The $450,000 received in 20X1 has a time restriction and is a deferred inflow of resources in 20X1.

Answer 605

A

As a deferred inflow on the balance sheet

Taxes collected in advance represent resources that pertain to a future time period in which they are legally due and therefore should be reported as deferred inflow of resources.

Answer 606

A

Current financial assets + Deferred outflows – Current financial liabilities – Deferred Inflows = Fund balance

Current financial assets + Deferred outflows – Current financial liabilities – deferred inflows = Fund balance is the accounting equation for governmental funds.

Answer 607

A

Deferred inflow of resources and deferred outflow of resources

GASB Concept Statement 4 established deferred inflows and deferred outflows of resources as financial statement elements.

Liabilities are not unique to governments.

Assets are not unique to governments.

Answer 608

A

Deferred inflow.

The $5,000,000 up-front payment is initially recorded as a deferred inflow of resources and revenue is recognized as the deferred inflow of resources is reduced.

A deferred outflow is for the consumption of net assets by the government that is applicable to a future period.

Other financing sources are financial resources, other than revenues, such as proceeds from long-term bonds.

Revenue should be recognized in a systematic and rational manner over the five-year term of the arrangement.

Answer 609

A

A deferred inflow of resources.

Since the Debt Service Fund uses the modified accrual basis of accounting, revenues are recognized when measurable and available. The $200,000 is not expected to be available and hence should be reported as a deferred inflow of resources in Year 20x1.

Answer 610

A

$0

The Debt Service Fund recognizes revenue when it is measurable and available. Since the first installment will be received 120 days into Year 20x2, no revenue is recognized in Year 20x1.

Answer 611

A

$1,000,000

The Debt Service Fund reports the amount that is measurable and available as revenue, which in Year 20x2 is the $1,000,000 collected

Answer 612

A

Deferred inflow of resources.

The remaining levy is measureable and available in Year 20x3 through Year 20x6 and is a deferred inflow of resources in Year 20x2.

Answer 613

A

Unrestricted
Restricted
Net investment in capital assets (which is
capital assets less accumulated depreciation
and less debt related to the capital asset)

Answer 614

A

Nonspendable
Restricted
Committed
Assigned
Unassigned

Answer 615

A

This balance is found only in the general fund.

Answer 616

A

False. Usually they are not displayed separately in
the financial statements. Encumbrances that do not
lapse are part of committed or assigned fund
balance, depending on the nature of the constraint
on resources.

Answer 617

A

They may be reported as restricted or committed
fund balance if the criteria for either type of
constraint are met. Otherwise, they will be reported
as unassigned fund balance. Stabilization funds are
usually reported in the general fund.

Answer 618

A

True. These fund balances should not report
negative amounts. Negative amounts can appear in
unassigned fund balance.

Answer 619

A

$14 million

Net investment in capital assets is the amount of long-term capital assets, net of accumulated depreciation, less the outstanding balance of capital-related debt. The gross value of the roads and equipment is $30 million. Accumulated depreciation on the roads and equipment totals $11 million and there is $5 million bonds payable outstanding related to the roads. The net investment in capital assets, therefore, is $14 million [$30 - $11 - $5 = $14]. Note that amounts related to inventory are distractors since inventory is not capital asset related.

Answer 620

A

$11 million

Three categories of net position make up total net position in government-wide financial statements: (1) net investment in capital assets net position, (2) restricted net position, and (3) unrestricted net position. Based on the information in the question, net investment in capital assets is $15 million calculated as $20 million less $5 million in accumulated depreciation. (The question is silent about whether the $7 million in liabilities is related to capital assets. If it was, you would also reduce net investment in capital assets by the liabilities related to capital assets.) Restricted net position is $3 million. Total net position is net investment in capital assets plus restricted net assets plus unrestricted net assets minus liabilities ($15 million + $3 million – $7 million = $11 million). There is no information about unrestricted net asset so you should assume that it is zero.

Answer 621

A

Unassigned.

Only the General Fund can report a positive amount in Unassigned Fund Balance. In all other Governmental Fund types (including a Special Revenue Fund), if expenditures exceed amounts restricted, committed, or assigned, it may be necessary to report a negative Unassigned Fund Balance. Should that occur, the Assigned Fund Balance is reduced to eliminate the deficit. If a deficit remains after eliminating Assigned Fund Balance, the negative residual should be classified Unassigned Fund Balance.

Answer 622

A

Nonspendable.

According to GASB Statement No. 54, a Nonspendable Fund Balance classification pertains to amounts that cannot be spent either because they are not in a spendable form (e.g., inventory) or are legally or contractually required to be maintained intact.

Answer 623

A

Unreserved Fund Balance.

GASB Statement No. 54 eliminated the use of “reserve” and “unreserved” fund balances. The appropriate fund balance classifications are Nonspendable, Restricted, Committed, Assigned, and Unassigned.

Answer 624

A

The encumbrances would only be reported in the note disclosures.

According to GASB Statement No. 54, outstanding encumbrances are no longer reported as Reserves in the fund balance section, which was the practice prior to Statement No. 54. Significant encumbrances should be disclosed in the notes to the financial statements.

Answer 625

A

Fund Balance Assigned.

$10,000 of the fund balance should be assigned to show that those funds are not available for appropriation in the next fiscal year.

There is no Budgetary Fund Balance-Reserved for encumbrances account on the balance sheet. The Budgetary Fund Balance account is used to reconcile the difference between estimated revenues and appropriations in the entry to record the budget.

A Deferred Expenditures account does not exist in governmental accounting.

The $10,000 represent a commitment to spend resources on goods and services that will be received in the future. Since the goods and services have not been received, no liability has been incurred. Therefore, Vouchers Payable should not report the $10,000.

Answer 626

A

Book value of capital assets sold during the year.

At the Governmental-Fund level, the entire proceeds from the sale of capital assets is a financial resource of the fund - it is spendable. Only the gain or loss on the sale of capital assets is reported in the Government-Wide Financial Statements. Therefore, the book value of capital assets should be subtracted.

Answer 627

A

Payment of interest and principal on general longterm debt

Answer 628

A

DR: Expenditures-Principal

CR: Cash

Answer 629

A

When the interest payment is due (i.e., on the due

date)

Answer 630

A

DR: Expenditures-Interest

CR: Cash

Answer 631

A

DR: Cash

CR: Other Financing Sources—Transfers In

Answer 632

A

DR: Due from Special Revenue Fund

CR: Cash

Answer 633

A

DR: Advances to Special Revenue Fund

CR: Cash

Answer 634

A

DR: Other Financing Uses—Transfers Out

CR: Cash

Answer 635

A

DR: Property Taxes Receivable
CR: Est. Uncollectible Property Taxes
CR: Property Tax Revenues

Answer 636

A

DR: Property Taxes Receivable
CR: Est. Uncollectible Property Taxes
CR: Deferred Inflow of Resources

Answer 637

A

DR: Property Tax Revenues

CR: Est. Uncollectible Property Tax

Answer 638

A

The deferred inflow of resources

Answer 639

A

DR: Cash

CR: Other Financing Sources—Bond Proceeds

Answer 640

A

DR: Expenditures

CR: Cash

Answer 641

A

The modified accrual basis

Answer 642

A

DR: Cash

CR: Other Financing Sources

Answer 643

A

When the resources are measurable (i.e., revenue
recognition is not deferred solely because of a
purpose restriction)

Answer 644

A

When the expenditure is made and reimbursement is

requested

Answer 645

A

The capital projects fund

Answer 646

A

DR: Cash

CR: Revenues—Grants

Answer 647

A

The debt service fund

Answer 648

A

The gain is added to the endowment principal; it is

not expendable.

Answer 649

A

Permanent Fund:
DR: Cash
CR: Revenues—Endowment Principal

Answer 650

A

Capital project

The primary purpose of a capital project fund is to account for resources dedicated to the acquisition and/or construction of long-term assets, such as this homeless shelter.

Special revenue funds are used to account for resources restricted for a particular purpose, such as mosquito abatement, but should not be used for long-term asset acquisition or construction.

Although the general fund is used to account for many different types of resources, federal grants typically require that the grant funds not be comingled in with other resources unrelated to the purpose of the grant as would be the case with a general fund.

A permanent fund is used to account for endowments from which the related earnings are to be used by the general government.

Answer 651

A

Revenue - $300,000
Other Financing Sources - $400,000

The $5,000 transferred from the Capital Projects Fund is recognized as an Expenditure Reimbursement (a credit to an expenditure account) rather than a Revenue.

The $400,000 transferred from the General Fund is recorded as an Other Financing Source - Transfer-in.

The federal grant is recognized as revenue immediately (e.g., the existence of a purpose restriction does not delay revenue recognition).

Answer 652

A

$300,000

The $450,000 transfer from the General Fund is classified as an Other Financing Source-Transfer In, but the $300,000 state grant is recognized as Revenue. Though the grant has not yet been received in Cash, GASB #33 requires that it be recognized as Revenue in the Government-Wide Statements when the receivable is recognized, as long as there are no eligibility restrictions. It would also be recognized as Revenue in the fund statements as long as the cash was received within 60 days of the year end.

Answer 653

A

$176,000

Both Interest Expenditures and Principal Expenditures are recognized in the Debt Service Fund. Debt Service Expenditures are usually not accrued at year-end but are recorded as Expenditures when due and payable. In 20x9 the Debt Service Fund paid a total of $176,000-$ $40,000 interest and $100,000 principal on April 1 (both Expenditures of the fund) and $36,000 interest on October 1.

Answer 654

A

The city should record $400,000 as revenue in a Permanent Fund.

Permanent Funds account for the receipt of the endowment principal that is donated to a government and is to be held in trust for the benefit of the government (or of its citizenry as a whole) as revenue.

Answer 655

A

$925,000

Permanent Funds account for the receipt of the endowment principal that is donated to a government and is to be held in trust for the benefit of the government (or of its citizenry as a whole) as revenue. The property should be capitalized at $925,000-fair market value at the time of donation ($800,000) plus the cost of improvements ($125,000) made by the city. Earnings from the office complex would usually be transferred to and expended through a Special Revenue Fund.

Answer 656

A

$1,980,000

Property taxes are an Imposed Nonexchange Revenue source for which the government receives value without directly giving something in equal value in exchange. In the Government-Wide Financial Statements, a Receivable is recorded when there is an enforceable claim - the property tax levy in this case - and Revenue should be recorded at the amount of Net Estimated Refunds and Estimated Uncollectible Amounts, in the period for which the taxes are levied [GASB Codification Section N50.115]. Given the facts in this question, revenue of $1,980,000 should be recognized ($2,000,000 gross levy less 1%, $20,000, estimated uncollectible amount). Had the question asked about revenue recognition in the General Fund, which uses the modified accrual basis of accounting, the answer would be different. In modified accrual accounting the concept of availability is an aspect of revenue recognition (GASB Codification Section P70.104]. Typically, that means that amounts collected during the year and up to 60 days into the next year are recognized in the current year as revenue. While the facts are incomplete in this question regarding the next year, the implication is that $1,800,000 would be recognized as revenues in the current year and $180,000 as deferred inflow of resources in the current year.

Answer 657

A

$100,000

Transfers between funds are classified as Other Financing Sources and Uses. The payment to the Pension Trust Fund pertains to employee and employer contributions to the pension plan and is part expenditure (employer share) and liability reduction (employee share that was due to the Pension Trust Fund). Under the modified accrual basis of accounting used by the General Fund, the purchase of the equipment is an expenditure.

Answer 658

A

Row D

This answer is correct because the General Fund should report only the $1,500,000 in the Other Financing Uses Control account as an Operating Transfer. The $3,000,000 in bonds proceeds should be reported in the Capital Projects Fund in the Other Financing Sources Control account.

Answer 659

A

General.

This answer is correct because the General Fund normally records the purchase of supplies. The supplies must be reported on the General Fund’s balance sheet, even though they do not represent current financial resources. In addition, at year end, a portion of the fund balance must be classified as nonspendable for the inventory amount because that amount of resources is not appropriable for future expenditures.

Answer 660

A

DR: Due from xxx

CR: Revenues (or Billings to Depts.)

Answer 661

A

DR: Capital Assets (Land, Building, Equipment)
CR: Contributions from xxx

Answer 662

A

Fees charged to external users

Answer 663

A

Fees charged to internal users

Answer 664

A

Equipment.

Enterprise Funds use accrual accounting and account for their fund-specific fixed assets. In accounting for capital leases an Enterprise Fund follows FASB ASC 840 - Leases, therefore the Equipment account should be debited for $150,000 at the inception of the lease.

Answer 665

A

$5,400,000

The statement of cash flows for an Enterprise Fund has four sections:

(1) cash flows from operating activities,
(2) cash flows from noncapital financing activities,
(3) cash flows from capital and related financing activities, and
(4) cash flows from investing activities. Both capital contributed by subdividers, $900,000, and proceeds from the sale of revenue bonds, $4,500,000, are considered cash flows from capital and related financing activities, therefore $5,400,000 is the correct answer.

The cash received from customer households, $2,700,000, is classified as cash flows from operating activities.

Answer 666

A

Nonoperating Revenues.

An Enterprise Fund is a type of Proprietary Fund.

Shared Revenues received by a Proprietary Fund for operating purposes should be recorded as Non-Operating Revenues in the period in which they are earned and become measurable.

Answer 667

A

General obligation bonds - No
Revenue bonds - No

Neither of the long-term obligations should be accounted for in Todd City’s general fund. Bonds directly related to and expected to be paid from Proprietary Funds (Water and Sewer Fund and Municipal Recreation Fund) should be included in the accounts of such funds. These are specific fund liabilities, even though the full faith and credit of Todd City has been pledged as further assurance that the obligations will be paid.

Answer 668

A

The pricing policies of the activity establish fees and charges designed to recover its cost.

There are two types of proprietary funds: (1) Internal Service Funds and (2) Enterprise Funds. Both use accrual accounting. They differ in terms of the primary user of their services and the pricing policy to set fees. Other governmental agencies/departments are the primary user of services provided by an internal service fund and the pricing policy is some portion of routine operating costs (e.g., from 50% to 100%). Motor pools, data processing, and self insurance are some examples of Internal Service Funds. External users are the primary users of services provided by an enterprise fund and the pricing policy is to recover operating costs, depreciation, and to provide for capital maintenance. This answer is correct.

Answer 669

A

$425,000

Enterprise funds use accrual accounting. The amount of compensated absences expense for the current year can be computed as: ending accrued compensated absences ($150,000) plus compensated absences paid ($400,000) less beginning compensated absences ($125,000), which amounts to $425,000.

Answer 670

A

$850,000

All of the long-term liabilities of these Enterprise Funds should be accounted for in the proprietary fund financial statements.

Answer 671

A

Operating Revenues Control.

New’s Internal Service Fund is a Proprietary Fund type and uses the accrual basis of accounting. It should recognize revenues when they are earned, not when cash is received.

When New’s Internal Service Fund bills New’s parks and recreation department for services rendered, it should record the following entry:

Due from Other Funds-Parks and Recreation 150,000
Operating Revenues Control 150,000

Answer 672

A

Most custodial funds accounts consist only of
current assets and current liabilities; they do not
recognize revenues, expenditures, or net position.
The exception is investment pools that are not
subject to a formal trust arrangement, which are
accounted for as custodial funds with restricted net
position for the external entities in the investment
pool.

Answer 673

A

DR: Cash $5,000,000
CR: Additions–Deposits in Pooled Investments for
Blake City $5,000,000

Answer 674

A

DR: Cash

CR: Additions—Employer Contributions

Answer 675

A

Net Position Held in Trust for Pension Benefits

Answer 676

A

Private-purpose trust funds

Answer 677

A

$11,300,000

In addition to the actual earnings on plan assets, both employer and employee contributions are recognized as Additions in the Pension Trust Fund.

Answer 678

A

The plan’s fiduciary net position as a percentage of the actuarially determined total pension liability..

According to GASB Statment No. 68 (para 46(b)(1)(d), governmental employers must report as required supplemental information, the pension plan’s fiduciary net position as a percentage of the actuarially determined total pension liability.

Answer 679

A

Private-Purpose Trust Fund.

A Private-Purpose Trust Fund is used to account for resources, both expendable and non-expendable, which either must be used for a non-governmental purpose or the earnings from which have to be used for a non-governmental purpose.

As in this case, Private-Purpose Trust Funds usually disburse monies to individuals or organizations outside the governmental entity.

Permanent Funds are used to segregate resources that must be invested in perpetuity, the earnings from which are to be used for a general government purpose.

Special Revenue Funds are used to accrue and expend resources for governmental purposes, not for private purposes.

Custodial Fund, the monies would have to be distributed to other entities in accordance with narrowly defined guidelines.

Custodial Funds cannot account for monies which must be retained in perpetuity.

Answer 680

A

None of the above. Revenues are not reported in Custodial Funds.

Custodial Funds act as intermediaries in the process of disbursing monies from one governmental entity to another. The government has no claim on the resources in the Custodial Fund and does not recognize revenues when it receives the monies or recognize expenses when the monies are disbursed; rather, additions and deductions are recognized.

Answer 681

A

Custodial Fund.

Custodial Funds are used to account for assets received on behalf of and paid to other funds, individuals, or organizations. The capital grant described in this question is an example of a pure pass-through grant in which Harland County acts as a conduit to distribute the funds to the five subrecipient municipalities. Hartland County will not record any revenues or expenditures related to the grant and will record a receivable and payable in the Custodial Fund that acts as a clearinghouse for the funds.

Private-Purpose Trust Funds account for the principal or corpus of a trust that must be held intact to produce income whose beneficiaries are private individuals, organizations, or other governments.

Special Revenue Funds are used to account for revenues sources that are restricted or committed to expenditure for purposes other than debt service or capital projects.

The General Fund is used to account for all activities not properly accounted for by another fund.

Answer 682

A

$10,000

Because the question is about the General Fund, which uses the modified accrual basis of accounting, only the $10,000 contribution to the pension plan, which is a use of financial resources in year 1, is recognized as pension expenditure. The Pension Trust Fund would report the $10,000 received from the General Fund as an “Addition” and not as revenue.

Both the $8,200 and $800 paid by Pension Trust Fund would be reported as “Deductions” in that fund and not as expenditures.

The actuarially-determined annual required contribution would be reported in the Required Supplemental Information (RSI) and also in the footnotes to the financial statements.

Answer 683

A

$500,000

Arlen should report the $500,000 of sales taxes that it has collected on behalf of others in a Custodial Fund. The $300,000 cash confiscated from illegal acts, which must be used to support law enforcement activities, a general government function, should be reported in a Special Revenue Fund.

Answer 684

A

Net investment in capital assets
Restricted net assets
Unrestricted net assets

Answer 685

A

Statement of activities

Answer 686

A

Enterprise funds (Internal service funds are primarily
adjusted into governmental activities since they
provide services to government. Some adjustment
may be necessary to business-type activities to the
extent that internal service funds provide services to
enterprise funds.)

Answer 687

A

Statement of net position

Statement of activities

Answer 688

A

Introductory
Financial
Statistical

Answer 689

A

A distinction between governmental and business-type activities.

The primary focus of the government-wide financial statements is to report two activities: governmental and business-type. The governmental activities are largely funded by nonexchange transaction revenues, such as property taxes, and business-type activities that rely mainly on user fees.

Fiduciary funds are not included in government-wide financial statements because the government acts merely as a custodian for others.

Unlike for-profit entities, government financial statements, including the two government-wide financial statements, only report on the current fiscal year. (Comparative data is often reported in management’s discussion and analysis.)

Answer 690

A

Notes to the financial statements.

GASB requires, as “required supplemental information,” information about the use of the modified approach for reporting infrastructure in the notes to the financial statements.

Answer 691

A

Required supplementary information

MD&A is required supplementary information (RSI) that is included in the financial section of the CAFR along with independent auditor’s report, basic financial statements, notes to the financial statements, and other RSI.

Answer 692

A

1

GASB rules allow the primary government to aggregate all discretely presented component units into a single column.

Answer 693

A

As part of the financial section of the comprehensive annual financial report.

Combining statements of nonmajor governmental funds, nonmajor enterprise funds, internal service funds, trust funds, and agency funds are included as part of the financial section of the comprehensive annual financial report.

The basic financial statements include government-wide financial statements and fund-level financial statements that on report major funds with a single column for nonmajor funds (that comes from the total column of the combining financial statement for nonmajor funds).

The statistical section provides information to give the reader a historical and trend perspective on the government. The broad categories of information are: (1) financial trends information, (2) revenue capacity information, (3) debt capacity information, (4) demographic and economic information, and (5) operating information. Most of the information is provided for a 10-year period.

Individual fund statements and schedules may appear as part of the notes to the financial statements, but this does not include combining financial statements, which are reported elsewhere.

Answer 694

A

Governmental Funds - Yes
Proprietary Funds - Yes
Fiduciary Funds - Yes

The CAFR includes Fund statements from all three fund categories. The government-wide statements include data from the Governmental and Proprietary Funds only.

Answer 695

A

The independent auditor’s opinion.

The auditor’s report is not part of the introductory section of the CAFR. It is part of the financial section of the CAFR.

Answer 696

A

It may be capitalized, but it is not required, and depreciation is not required.

GASB Statement no. 34 para. 27-29, provides not-for-profit organizations with an option to not recognize contributions of donated works or art, historical treasures, or similar assets that are added to collections if the following conditions are met:

they are held for public exhibition, education, or research in furtherance of public service rather than financial gain;
are protected, kept unencumbered, cared for, and preserved;
or are subject to a policy that requires the proceeds of items that are sold to be used to acquire other items for the collection.
Capitalized collections or individual items that are exhaustible, such as exhibits whose useful lives are diminished by display or educational or research applications, should be depreciated over their estimated useful lives. Depreciation is not required for collections or individual items that are inexhaustible. In this question, neither capitalization nor depreciation is required.

Answer 697

A

The financial statements required for Enterprise Funds, including MD&A and RSI.

Special-purpose governments engaged in business-type activities follow the reporting standards required for Enterprise Funds, which are a Statement of Net Position; Statement of Revenues, Expenses, and Changes in Net Position; Statement of Cash Flows; and appropriate disclosures in MD&A, and RSI.

Governmental Fund financial statements report according to the modified accrual basis of accounting and, therefore, are not appropriate for business-type activities.

Answer 698

A

General Capital Asset.

The Government-Wide Financial Statements will present both the asset and the liability associated with a capital lease asset.

“Other financing use” is an account at the fund-level and does not appear in the Government-Wide Financial Statements.

“Expenditure” would be used in the Governmental Fund Statement but not in the Government-Wide Financial Statements.

Answer 699

A

Legally separate organizations:
Which are fiscally dependent on the primary
government and the organization provides
benefits to or financial burdens on the primary
government; OR
For which the primary government appoints a
voting majority of the component unit’s
governing board and either: (1) the primary
government is financially accountable for the
component unit; or (2) it would be misleading
or incomplete to exclude the component unit
from the primary government’s financial
statements

Answer 700

A

If the component unit is, in substance, a part of the
primary government (e.g., the principal beneficiary
of the component units services is the primary
government), the component unit’s debt is to be
paid entirely (or nearly so) by the primary
government, and the governing body of the
component unit is substantially the same as that of
the primary government, it should be blended.
Blended component units are much more rare than
discretely presenting component units.

Answer 701

A

A separately elected governing body
A legally separate entity
Fiscal independence

Answer 702

A

A column of aggregated totals for the component
units is added to the right of the primary
government’s data.

Answer 703

A

A primary government and its component units

Answer 704

A

The component unit’s totals are included with the
primary government’s data in the Governmental
Activities and Business-type activities columns, as
appropriate for each component unit.

Answer 705

A

The primary government has an ongoing financial interest in a joint venture, which pays its surpluses to the joint venture participants.

A joint venture is a legal entity or other organization that results from a contractual arrangement and that is owned, operated, or governed by two or more participants as a separate and specific activity subject to joint control. “Joint control” means that no single participant has the ability to unilaterally control the financial or operating policies of the joint venture. The joint venture is not included as a component unit. The primary government reports its equity interest in government-wide financial statements and in the affected fund-level statements.

Answer 706

A

The potential component unit sets user fees without authority of the primary government.

The ability to raise its fee structure without primary government approval is an example of fiscal independence.

The ability of the primary government to veto, overrule, or modify decisions made by the potential component unit’s governing body is an example of the primary government imposing its will on the potential component unit.

The ability of the primary government approve the budget of the potential component unit (PCU) is evidence of the primary government being able to impose its will on the PCU.

Answer 707

A

A component unit.

Excel City has appointment authority and has a financial burden relationship with the museum.

Special-purpose governments provide a single or limited number of functions, such as airport authorities or school districts. Special-purpose governments have the power to levy and collect taxes to raise revenues to finance the services that they provide.

If an organization is jointly controlled by two or more participants but there is no ongoing financial interest or ongoing financial responsibility, it is a jointly controlled organization.

A joint venture occurs when two or more participants are in joint control of a separate and special activity. “Joint control” means that no single participant has the ability to unilaterally control the financial or operating policies of the joint venture. The participants have an equity interest in the joint venture.

Answer 708

A

It is fiscally dependent on the other entity and a benefit or burden relationship exists with the other entity.

Fiscal dependence plus a financial benefit or burden relationship indicates financial accountability by the primary government for the component unit.

Appointment authority is part of the criteria to determine financial accountability, but it must be combined with additional criteria.

A financial burden is part of the criteria to determine financial accountability, but it must be combined with additional criteria.

A financial benefit/burden is part of the criteria to determine financial accountability, but it must be combined with additional criteria.

Answer 709

A

The district is not subject to major fund reporting criteria.

This statement is false. The district should be evaluated to determine whether or not it meets the criteria of a major fund.

This statement is true. The district has the same governing body, and a financial burden relationship exists. Since the governing bodies are identical and the district provides services only to the city, the district is a component unit deemed to be part of the city in substance, and therefore the blended approach should be used.

This statement is true. Since the district is an enterprise fund, it may be reported as a separate column of the Proprietary Fund financial statements if it meets the criteria for a major fund and as part of the business-type activities in the two government-wide financial statements.

This statement is true. The district meets the criteria for blended presentation because the district has the same governing body, and a financial burden relationship exists. Since the governing bodies are identical and the district provides services only to the city, the district is a component unit deemed to be part of the city in substance, and therefore the blended approach should be used.

Answer 710

A

A joint venture.

The city and county jointly govern the authority, and each has an ongoing financial responsibility. Both the city and the county will report their equity interest in the joint venture as business-type activities in the government-wide financial statements.

Neither the city nor the county appoints a voting majoring of the authority’s governing body.

Jointly governed organizations are subject to the joint control or two or more participating governments, but there is neither an ongoing financial interest nor an ongoing financial responsibility.

A related organization is one in which a primary government has met the appointment authority criterion but is not financially accountable for the organization. That is, the primary government does not have the ability to impose its will and does not have a financial benefit or burden relationship with it.

Answer 711

A

Is included in the government-wide statements only.

Discretely presented component units are presented in the Government-Wide Financial Statements only and not in the fund-level statements.

Answer 712

A

A discretely presented component unit of the town.

The Metro Transportation Authority (MTA) is a discretely presented component unit of the town of Metro because it is financially accountable to the town since the MTA’s budget must be approved by the town’s governing board, which also appoints a voting majority of the MTA’s board.

Answer 713

A

Not at all.

According to GASB Statement No. 61 (para 6), Excel City would have to appoint a voting majority of Excel ISD’s governing body. The criteria for financial accountability require that, in addition to the primary government being able to impose its will on the component unit (e.g. approve the budget), at least 50% of the governing body of the component unit be appointed by the primary government. In this case, the governing body is independently elected and so does not meet the criteria for inclusion as a component unit.

Answer 714

A

Discrete presentation.

Two approaches are used for component units: (1) discrete presentation in a separate column of the Government-Wide Financial Statements and (2) blended with the primary government.

Answer 715

A

Statement of net position

Statement of activities

Answer 716

A

Major funds. Major funds meet two thresholds:
1. 10% of combined balances (e.g., revenues) of
all governmental fund types and
2. 5% of combined balances of governmental
and enterprise fund.
The general fund is always a major fund.

Answer 717

A

The general fund

Answer 718

A

10% of total assets and deferred outflows of
resources, liabilities, and deferred inflows of
resources, revenues, or expenditures/expenses of
the total for all funds in that fund type and at least
5% for the same element for all governmental and
enterprise funds combined

Answer 719

A

General funds

Major special revenue funds

Answer 720

A

Internal service funds and fiduciary fund types

Answer 721

A

10% of the corresponding element(s) of total governmental funds and 5% of the corresponding element(s) of total governmental and enterprise funds combined.

Note also the fiduciary funds and internal service funds are never major funds.

Answer 722

A

Neither the Development Special Revenue Fund nor the Debt Service Fund should be reported as major.

The General Fund is always a major fund. Other governmental funds are major funds if the element (assets in this question) exceed 10% of total governmental fund assets ($800,000) and 5% of total governmental fund and enterprise fund assets combined ($900,000).

Answer 723

A

Four

Fiduciary funds are not subject to major fund criteria and therefore are reported in a separate column for each of the four types of fiduciary funds since none of the custodial funds is related to an investment pool. Combining statements can be used to disclose information on each fiduciary fund.

Answer 724

A

In fund-level financial statements by fund type.

Fiduciary funds are reported in fund-level statements and not in the government-wide financial statements.

Answer 725

A

Four

Fiduciary funds are not subject to major fund criteria and therefore are reported in a separate column for each of the four types of fiduciary funds. Combining statements can be used to disclose information on each fiduciary fund.

Answer 726

A

Three

The general fund is always a major fund. The general fund and the two other governmental funds that meet the criteria for major fund reporting will be reported separately in the governmental fund-level financial statements. The other two nonmajor governmental funds will be reported in aggregate in a column entitled “Other Governmental Funds.”

Answer 727

A

Enterprise funds

Enterprise funds and governmental funds are eligible for major fund reporting if they meet the criteria of a major fund. The general fund is always a major fund.

Fiduciary funds are never major funds.

Answer 728

A

$ 7,500

The increase in the fund balance for Governmental Funds is measured on the modified accrual basis, while the Change in Net Position for governmental activities is measure on the full accrual basis. To convert the increase in fund balance to full accrual:

Increase in Fund Balance + $1,500
Add back the Expenditures related to the purchase of capital assets + 9,000
Deduct the depreciation expense not included in Fund Balance - 3,000
Change in Net Position $7,500

Answer 729

A

$34,000

GASB Stmt. #34 requires that Internal Service Funds be included in the Governmental Activities totals on the Government-Wide Statements since Internal Service Funds supply goods or services only to the government entity.

Therefore, the total fund balance for the Governmental Funds in the fund-based statements ($25,000) must be increased by the Net Position of the motor pool ($9,000) when the preparing the Governmental Activities column of the Government-Wide Statement of Net Position ($25,000 + 9,000 = $34,000).

Answer 730

A

A schedule showing the original budget, the final appropriations budget, and actual inflows, outflows, and balances on a budgetary basis.

The Budgetary Comparison Schedule must report the original budget, the amended/final budget, and actual revenues and expenditures. The revenues and expenditures must be reported using the same basis used to prepare the budget: governmental budgets are frequently prepared on a cash or near-cash basis.

Answer 731

A

The net amount of governmental fund interfund
payables to and receivables from enterprise funds
are reclassified as “Internal Balances” in the
government-wide statement of net position.

Answer 732

A

Current assets and current liabilities of the internal
service fund are adjusted into government-wide
governmental activities. An adjustment of “Internal
Balances” is made for a net amount of the internal
service fund operations allocated to business-type
activities, if any. Capital assets and long-term
liabilities of the Internal Service Fund will be
included in the adjustments to add capital assets,
accumulated depreciation, and long-term liabilities.

Answer 733

A

1. Add general capital assets and related
accumulated depreciation.
2. Add general long-term liabilities.
3. Convert categories of fund balance to
categories of net position.

Answer 734

A

Decrease expenses by $15,000.

The general government departments have recorded a total of $50,000 in expenditures related to billings from the internal service fund. The conversion to government-wide financial statements requires the elimination of the $15,000 “profit” by decreasing the $50,000 expenditure to $35,000 and reclassifying it as “expense.”

Answer 735

A

Adjustments related to internal service funds.

Enterprise funds use the economic resources measurement focus and the accrual basis of accounting, which is also used in government-wide financial statements. Internal service fund activities utilized by enterprise funds are the primary adjustment to enterprise fund financial information.

Answer 736

A

Capital outlay expenditures

Capital outlay expenditures in the governmental fund-level financial statements are eliminated in converting to governmental-wide financial statements. The adjustment is an increase in reconciling changes in fund balance, at the governmental fund level, to changes in net position at the government-wide level.

Answer 737

A

It is an alternative to depreciation of infrastructure
assets based on maintaining the condition of
infrastructure assets.

Answer 738

A

They are reported as a decrease in bonds payable in
government-wide financial statements and as an
expenditure in the debt service fund-level financial
statements.

Answer 739

A

They are reported as an increase to long-term assets
in government-wide financial statements and as an
expenditure in the capital projects fund-level
financial statements.

Answer 740

A

They are reported as a liability in the governmentwide financial statements and as other financing
sources—bond proceeds in the capital projects fundlevel financial statements.

Answer 741

A

Due from xxx

Answer 742

A

Advances to xxx

Answer 743

A

At the “cash-generating unit” level

Answer 744

A

It is impaired when book value exceeds its fair value

less cost to sell at the end of the reporting period.

Answer 745

A

No depreciation expense is required to be recognized.

Under the modified approach, infrastructure assets that are part of a network or subsystem of a network need not be depreciated if the government uses an asset management system that documents that the assets are being preserved approximately at (or above) a condition level established and disclosed by the government.

the modified approach the government must document and complete condition assessments every three years and the three most recent assessments should provide reasonable assurance that assets are being preserved at or above the established and disclosed condition level.

Under the modified approach, infrastructure assets that are part of a network or subsystem of a network need not be depreciated if the government uses an asset management system that documents that the assets are being preserved approximately at (or above) a condition level established and disclosed by the government.

Maintenance and repair expenses are anticipated by the modified approach and are incurred to “preserve” the condition of the assets. Under the modified approach, these expenditures are a substitution for depreciation.

Answer 746

A

$ 5,000

There for five types of interfund transactions: (1) loans, (2) reciprocal quasi-external transactions, (3) reimbursements, (4) residual transfers, and (5) operating transfers. A reciprocal transaction occurs from doing business with one another, such as the billing of services by an internal service fund to other funds/departments in the government.

Answer 747

A

Operating Transfer of $150,000.

General Fund transfers to the Debt Service Fund to provide for the servicing of debt is an example of a regular, routine, reoccurring transfer of resources between funds to subsidize current activities that are classified as Operating Transfers.

Answer 748

A

Buildings.
Infrastructure assets are capital assets that are normally stationary and can be preserved for a longer time than most capital assets. Common infrastructure assets include roads, bridges, sewer systems, lighting systems, and drainage. Buildings are not infrastructure assets.

Answer 749

A

Government-wide financial statements.

The government-wide financial statements are used to account for all unmatured long-term indebtedness of the government, except for that debt belonging to Proprietary and similar Trust Funds. The liability for the general obligation bonds should be recorded in this account group.

Answer 750

A

$4,000,000 in 2011.

The Capital Project Fund records the entire amount of the bond proceeds as an Other Financing Source in the year that the proceeds are received. Even though the expenditures are to occur over two years, under modified accrual accounting, the entire amount of the proceeds are recorded as a resource of the fund when received.

Answer 751

A

They are recognized on the modified accrual
accounting basis of accounting and should be equal
to the amount expected to be liquidated with
expendable available financial resources.

Answer 752

A

It is reported in its entirety in the government-wide
financial statements and recognized in the fundlevel statements to the extent that amounts are
payable from expendable available financial
resources.

Answer 753

A

They should report expenditures accrued that year
for which there are expendable available financial
resources.

Answer 754

A

Choice IV

All three events are obligating events that require recognition of a pollution remediation obligation.

Answer 755

A

Revenue bonds issued by an enterprise fund

Revenue bonds issued by an enterprise fund are reported within business-type activities in government-wide financial statements.

Capital lease obligations for general capital assets are reported within governmental activities in government-wide financial statements

Tax-supported general obligation bonds are reported within governmental activities in government-wide financial statements.

The long-term portion of claims and judgments is reported within governmental activities in government-wide financial statements.

Answer 756

A

Capitalized equipment leases of the sewerage and wastewater utility fund

The capitalized lease obligation of the sewerage and wastewater utility fund is recognized within the business-type activities of the government-wide financial statements.

The capital lease obligation for administrative office computers the liability is recognized within the governmental activities of the government-wide financial statements.

Compensated absences of the fire department the liability are recognized as expenses within the governmental activities of the government-wide financial statements.

Because the liability is related to the city’s public works division, the liability is recognized within the governmental activities of the government-wide financial statements.

Answer 757

A

Both I and II

Portions of the cost of the final cover and of gas monitoring systems are included.

Answer 758

A

An other financing source.

The general fund will record an expenditure and an other financing source at the inception of the lease.

Answer 759

A

Report expenditures of $100,000 in Year 1.

Governmental funds report only the portion that is due and payable from available current financial resources..

Answer 760

A

Pension benefits.

Pension benefits are not an example of other postemployment benefits.

Example of other postemployment benefits:
Life insurance.
Dental benefits
Medical insurance

Answer 761

A

$20,000,000

All of the items listed are Unmatured Long-Term Liabilities of the general government that will not be recorded in any of the Governmental Funds but will appear as liabilities in the Government-Wide Statement of Net Position.

Answer 762

A

$0

The Water Utility Enterprise Fund uses full accrual accounting and will account for and report on the bonds in the Enterprise Fund. Therefore, this liability appears in the business-type activity section of the government-wide financial statements and not in the governmental activity section.

Answer 763

A

The General Fund statements should report expenditures and a current liability of $100,000, and the government-wide statements should report a long-term liability of the present value of the $400,000.

The $100,000 portion of the judgment due in the current year is reported in the General Fund and will appear as expenditures in the fund-level statements. The unmatured $400,000 portion is reported in the Government-Wide Statements as a liability at present value. The long-term portion of the liability is RECORDED in the Schedule of General Long-term Debt.

Answer 764

A

Failure to meet:
Time restrictions or
Eligibility requirements

Answer 765

A

Character (Debt Service, Current, Capital Outlay)

Answer 766

A

Program or Function

Answer 767

A

Derived tax revenues
Imposed exchange revenues
Government-mandated nonexchange
transactions
Voluntary nonexchange transactions

Answer 768

A

This is a true statement. The sales tax revenue is

derived from the sale of products.

Answer 769

A

This is a true statement.

Answer 770

A

This is a true statement.

Answer 771

A

Derived tax revenue

Sales taxes are “derived” from underlying taxable exchange transactions of individuals and businesses.

Government-mandated nonexchange transactions occur when a senior government legally mandates implementation of a particular program by the recipient government.

Imposed nonexchange transactions occur when the government receives something of value without giving anything of equal value in return, such as property taxes imposed on taxpayers by the government.

Government-mandated nonexchange transactions occur when a senior government legally mandates implementation of a particular program by the recipient government.

Voluntary nonexchange transactions occur when a grantee applies for a grant.

Answer 772

A

$3,845,000

$3,845,000 is correct because it includes $35,000 in fines collected, $3,310,000 in current- and prior-year property taxes collected, and $500,000 in grants received and earned.

Answer 773

A

Capital outlays

Capital outlays are reported differently in government-wide financial statements and governmental fund-level financial statements. Capital outlays are reported as expenditures in the governmental fund financial statements and as increases in capital assets in the government-wide financial statements.

Answer 774

A

$1,980,000

The entity-wide statements are presented on the full accrual basis and hence used GASB #33 Revenue recognition rules.

GASB #33 requires that property taxes net of the estimated uncollectible taxes be recognized as Revenue in the year for which they were levied, regardless of when cash is actually collected.

Answer 775

A

Budgetary Fund Balance.

The entry to record a purchase order is a debit Encumbrances and a credit to Budgetary Fund Balance.

Vouchers Payable is used to record invoices for goods and services received.

Appropriation Control is used to record the original legally adopted budget, any subsequent revisions to the budget, and to close out the budget at year-end.

Answer 776

A

Property taxes.

Property taxes are both objectively measurable and available to finance current period expenditures and, therefore, are “susceptible for accrual,” and revenues are recorded prior to when cash is collected.

Licenses and permits are not objectively measurable.

Fines and forfeits are not objectively measurable.

Service charges are not objectively measurable.

Answer 777

A

Water Utility Fund.

“Expense” is a term reserved for funds that use full accrual accounting. A Water Utility Fund is an Enterprise Fund type using full accrual accounting.

The General Fund is a Governmental Fund type that uses modified accrual and the term “expenditures.”

Pension Trust Funds are Fiduciary Funds. Pension Trust Funds account for the assets of others (i.e., current and retired employees) and salaries expense should not appear in this fund type.

Answer 778

A

Object.

“Supplies” is one of the object classes of expenditures, which describe the type of item purchased or service obtained.

Character classes of Expenditures describe period or periods benefited (i.e., current operating, capital outlay, debt service) or as intergovernmental.

Functional classes of Expenditure describe the department or organization unit associated with the expenditure (e.g., Public Safety).

The fund class of Expenditure describes the fund that accounted for the expenditure (e.g., General Fund).

Answer 779

A

The relationship between the amount of value given and received.

Exchange Transactions involve a direct relationship between the charge and the service. Nonexchange Transactions, which are frequent in governments, do not have this relationship (e.g., taxes and fines).

Answer 780

A

At estimated fair value when received.

Donated fixed assets should be recorded in the fund to which they relate or in the General Fixed Asset Account group, as appropriate, at their estimated fair value when received. GASB 1400.113

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