Final Review July 2023

Question 1

According to the FASB’s conceptual framework, comprehensive income includes which of the following?

Answer 1

Yes Yes

Comprehensive income is the periodic change in equity of a business from nonowner sources. Accordingly, comprehensive income is a broad concept that includes not only revenues, expenses, gains, and losses recognized in net income but also other nonowner changes in equity, such as holding gains and losses on available-for-sale debt securities and foreign currency translation adjustments. Furthermore, intermediate components of net income such as gross margin, income from continuing operations before taxes, income from continuing operations, and operating income are included.

Question 2

A U.S. public company with a worldwide public float of $800 million at the end of the second quarter of the fiscal year is required to file its annual report with the U.S. SEC on

1. Form 10-Q within 45 days after the end of the reporting period.
2. Form 10-K within 60 days after the end of the reporting period.
3. Form 10-Q within 40 days after the end of the reporting period.
4. Form 10-K within 75 days after the end of the reporting period.

Answer 2

2. Form 10-K within 60 days after the end of the reporting period.

After registration with the SEC, an issuer is required to file many different forms. Large accelerated filers [companies with a public float (the market value of shares held by the public) of $700 million or more] must file Form 10-K within 60 days of the last day of the fiscal year.

Question 3

A newly acquired plant asset is to be depreciated over its useful life. What is the basis for this accounting method?

Economic-entity assumption.
Going-concern assumption.
Materiality.
Monetary-unit assumption.

Answer 3

Going-concern assumption.

A basic feature of financial accounting is that the business entity is assumed to be a going concern in the absence of evidence to the contrary. The going-concern concept is based on the empirical observation that many entities have indefinite lives. The reporting entity is assumed to have a life long enough to fulfill its objectives and commitments and therefore to depreciate wasting assets over their useful lives.

Question 4

Accrual accounting involves accruals and deferrals. Which of the following best describes accruals and deferrals?

1. Accruals are concerned with expected future cash receipts and payments, while deferrals are concerned with past cash receipts and payments.
2. Both accruals and deferrals are concerned with past cash receipts and payments.
3. Accruals are concerned with past cash receipts and payments, while deferrals are concerned with expected future cash receipts and payments.
4. Both accruals and deferrals are concerned with expected future cash receipts and payments.

Answer 4

1. Accruals are concerned with expected future cash receipts and payments, while deferrals are concerned with past cash receipts and payments.

Accrual accounting records the financial effects of transactions and other events and circumstances on an entity’s economic resources and claims to them when they occur. Under accrual accounting, accruals anticipate future cash flows, and deferrals reflect past cash flows.

Question 5

In the determination of a present value, which of the following relationships is true?

1. The higher the discount rate and the longer the discount period, the lower the present value.
2. The lower the future cash flow and the shorter the discount period, the lower the present value.
3. The lower the discount rate and the shorter the discount period, the lower the present value.
4. The higher the future cash flow and the longer the discount period, the lower the present value.

Answer 5

1. The higher the discount rate and the longer the discount period, the lower the present value.

As the discount rate increases, the present value decreases. Also, as the discount period increases, the present value decreases.

Question 6

Under SFAC No. 8, Conceptual Framework for Financial Reporting, Chapter 4, Elements of Financial Statements, interrelated elements of financial statements include

Answer 6

Yes No

Distributions to owners are directly related to measuring the performance and status of a business enterprise.

The elements of financial statements directly related to measuring the performance and status of business enterprises and nonbusiness organizations are (1) assets, (2) liabilities, (3) equity of a business or net assets of a nonbusiness organization, (4) revenues, (5) expenses, (6) gains, and (7) losses. The elements of (1) investments by owners, (2) distributions to owners, and (3) comprehensive income relate only to business enterprises. Information disclosed in notes or parenthetically on the face of financial statements amplifies or explains information recognized in the financial statements.

Question 7

Which of the following adjustments is necessary to convert cash receipts to revenues as reported on an accrual basis?

1. Add beginning accounts receivable to cash receipts from customers.
2. Subtract ending contract liability from cash receipts from customers.
3. Subtract beginning contract liability from cash receipts from customers.
4. Subtract ending accounts receivable from cash receipts from customers.

Answer 7

2. Subtract ending contract liability from cash receipts from customers.

Generally, under the accrual basis, revenue is recognized when the promised good or service is transferred to a customer. A contract liability is an obligation to transfer goods or services to a customer for which the consideration already has been received from the customer. Thus, to convert cash receipts to revenues recognized under the accrual method, the ending contract liability must be subtracted from the cash receipts from customers.

Question 8

A company purchased some large machinery on a deferred payment plan. The contract calls for $40,000 down on January 1 and $40,000 at the beginning of each of the next 4 years. There is no stated interest rate in the contract, and there is no established exchange price for the machinery. What should be recorded as the cost of the machinery?

1. $200,000 plus the added implicit interest.
2. Future value of an annuity due for 5 years at an imputed interest rate.
3. $200,000.
4. Present value of an annuity due for 5 years at an imputed interest rate.

Answer 8

4. Present value of an annuity due for 5 years at an imputed interest rate.

The contract calls for an annuity due because the first annuity payment is due immediately. In an ordinary annuity (annuity in arrears), each payment is due at the end of the period. According to GAAP, an interest rate must be imputed in the given circumstances to arrive at the present value of the machinery.

Question 9

On January 2, Year 1, Air, Inc., agreed to pay its former president $300,000 under a deferred compensation arrangement. Air should have recorded this expense in Year 1 but did not do so. Air’s reported income tax expense would have been $70,000 lower in Year 1 had it properly accrued this deferred compensation. In its December 31, Year 2, financial statements, Air should adjust the beginning balance of its retained earnings by a

$230,000 credit.
$230,000 debit.
$300,000 credit.
$370,000 debit.

Answer 9

$230,000 debit.

Error corrections in single-period statements are reflected net of applicable income taxes as changes in the opening balance in the statement of retained earnings of the current period. The net effect of the error on Year 1 after-tax income was to understate expenses and overstate income by $230,000 ($300,000 expense – $70,000 tax savings). Consequently, beginning retained earnings should be debited (decreased) by $230,000.

Question 10

Volga Co. included a foreign subsidiary in its Year 6 consolidated financial statements. The subsidiary was acquired in Year 4 and was excluded from previous consolidations. The change was caused by the elimination of foreign currency controls. Including the subsidiary in the Year 6 consolidated financial statements results in an accounting change that should be reported

1. By note disclosure only.
2. Currently and prospectively.
3. Currently with note disclosure of pro forma effects of retrospective application.
4. By retrospective application to the financial statements of all prior periods presented.

Answer 10

4. By retrospective application to the financial statements of all prior periods presented.

A change in the reporting entity requires retrospective application to all prior periods presented to report information for the new entity. The following are changes in the reporting entity: (1) presenting consolidated or combined statements in place of statements of individual entities, (2) changing the specific subsidiaries included in the group for which consolidated statements are presented, and (3) changing the entities included in combined statements.

Question 11

How should the effect of a change in accounting estimate be accounted for?

1. By retrospectively applying the change to amounts reported in financial statements of prior periods.
2. By reporting pro forma amounts for prior periods.
3. As a prior-period adjustment to beginning retained earnings.
4. By prospectively applying the change to current and future periods.

Answer 11

4. By prospectively applying the change to current and future periods.

The effect of a change in accounting estimate is accounted for in the period of change, if the change affects that period only, or in the period of change and future periods, if the change affects both. For a change in accounting estimate, the entity may not (1) restate or retrospectively adjust prior-period statements or (2) report pro forma amounts for prior periods.

Question 12

On January 2, Year 4, Raft Corp. discovered that it had incorrectly expensed a $210,000 machine purchased on January 2, Year 1. Raft estimated the machine’s original useful life to be 10 years and its salvage value at $10,000. Raft uses the straight-line method of depreciation and is subject to a 30% tax rate. In its December 31, Year 4, financial statements, what amount should Raft report as a prior period adjustment?

$102,900
$105,000
$165,900
$168,000

Answer 12

$105,000

Expensing the machine in Year 1 resulted in an after-tax understatement of net income equal to $147,000 [$210,000 × (1.0 – .30 tax rate)]. Not recognizing annual depreciation of $20,000 [($210,000 – $10,000 salvage value) ÷ 10 years] in Years 1-3 resulted in an after-tax overstatement of net income equal to $42,000 [($20,000 × 3 years) × (1.0 – .30 tax rate)]. Thus, the prior period adjustment is for a net understatement of $105,000 ($147,000 – $42,000).

Question 13

On January 1, Year 1, an entity receives a payment of $20,000 for delivering a product to a customer at the end of Year 3. Based on the contract’s terms, the performance obligation will be satisfied at a point in time (upon delivery of the product). The entity determined that (1) the contract includes a significant financing component and (2) a financing rate of 6% is an appropriate discount rate. What amount of interest expense and contract liability will be recognized in the entity’s December 31, Year 2, financial statements?

Answer 13

Year 2 Interest Expense = $1,272
Contract Liability on December 31, Year 2 = $22,472

Until the product is delivered to the customer, all payments received are recognized as a contract liability. Because the contract includes a significant financing component, interest expense is recognized using the effective interest method. The contract liability at the beginning of Year 2 equals $21,200 ($20,000 × 1.06). Thus, Year 2 interest expense equals $1,272 ($21,200 × 6%), and the contract liability at the end of Year 2 equals $22,472 ($21,200 × 1.06).

Question 14

The transaction price from contracts with customers generally should not be adjusted for the effect of the time value of money when

1. The transfer of goods is at the discretion of the seller.
2. A substantial amount of the consideration is contingent on a future event that is not within the control of the seller.
3. The time between the payment and the delivery of the promised goods in the contract to the customer is 18 months.
4. The selling price of the product and the consideration promised in the contract differ significantly.

Answer 14

2. A substantial amount of the consideration is contingent on a future event that is not within the control of the seller.

The transaction price should not be adjusted for the effect of the time value of money if

1. The time between the payment and the delivery of the promised good or service to the customer is 1 year or less.
2. The transfer of goods or services is at the discretion of the customer (e.g., a bill-and-hold contract in which the seller provides storage services for goods it sold to the buyer).
3. A substantial amount of the consideration promised is variable, and its amount or timing varies on the basis of future circumstances that are not within the control of the entity or the customer. An example is a sales-based royalty contract in which the amount of consideration depends on sales by the customer to third parties.

Question 15

Which of the following can be used to estimate the standalone selling price of a performance obligation in a contract with customers when that price is not directly observable?

Answer 15

Adjusted Market Assessment = Yes
Expected Cost Plus an Appropriate Margin = Yes

The adjusted market assessment and the expected cost plus an appropriate margin are acceptable estimates of the standalone selling price of a performance obligation when that price is not directly observable. Using the adjusted market assessment approach, an entity evaluates the market in which it sells goods or services and estimates the price that a customer in that market would be willing to pay for them. Using the expected cost plus an appropriate margin approach, an entity forecasts its expected costs of satisfying a performance obligation and adds an appropriate margin for that cost.

Question 16

A promised asset is transferred in full satisfaction of a performance obligation in a contract when the customer

Obtains control of the asset.
Can direct use of the product.
Has physical possession of the asset.
Pays for the asset in full.

Answer 16

Obtains control of the asset.

Revenue is recognized when a performance obligation is satisfied by transferring a promised good or service to a customer. It happens when the customer obtains control of the good or service (i.e., an asset). Control of an asset is transferred to the customer when the customer (1) has the ability to direct the use of the asset and (2) obtains substantially all of the remaining benefits (potential cash flows) from the asset.

Question 17

According to the guidance for recognition of revenue from contracts with customers (ASC 606), the incremental costs of obtaining a contract with a customer that are expected to be recovered must be

1. Reported as an item of other comprehensive income.
2. Recognized as an item of equity.
3. Recognized as an asset and amortized in subsequent periods.
4. Recognized directly in the income statement.

Answer 17

3. Recognized as an asset and amortized in subsequent periods.

The incremental costs of obtaining a contract with a customer must be capitalized (recognized as an asset) if the entity expects to recover them. These costs would not have been incurred if the contract had not been obtained. The cost capitalized (asset recognized) must be amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.

Question 18

In external financial reporting of segment data, which of the following must be used to determine a reportable operating segment’s profit or loss?

1. Significant noncash items other than depreciation, depletion, and amortization expense.
2. Income tax expense.
3. The internal measure of segment profit or loss reported to the chief operating decision maker.
4. Items that are unusual in nature but do not occur infrequently.

Answer 18

3. The internal measure of segment profit or loss reported to the chief operating decision maker.

Segmentation for external reporting purposes is based on the structure of an entity’s internal organization, that is, an alignment of external with internal reporting. Accordingly, the amount of a segment item reported, such as profit or loss, is the measure reported to the chief operating decision maker for purposes of making resource allocation and performance evaluation decisions regarding the segment. However, GAAP do not stipulate the specific items included in the calculation of that measure.

Question 19

Subsequent events include which of the following?

II only.
Neither I nor II.
Both I and II.
I only.

Answer 19

Both I and II.

Subsequent events are events or transactions that occur after the balance sheet date and prior to the issuance (or availability for issuance) of the financial statements. Certain subsequent events or transactions provide evidence about conditions at the date of the balance sheet, including the estimates inherent in statement preparation. Other subsequent events or transactions provide evidence about conditions that did not exist at the date of the balance sheet.

Question 20

Bard Co., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Bard had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Bard report as income tax expense in its interim income statement for the second quarter?

$5,000
$3,500
$7,500
$6,000

Answer 20

$6,000

Interim period tax expense equals the estimated annual effective tax rate, times year-to-date “ordinary income,” minus the tax expense recognized in previous interim periods. Accordingly, the income tax expense reported in the interim income statement for the second quarter is calculated as follows:

Question 21

How are discontinued operations and material unusual or infrequently occurring items that occur at midyear initially reported?

1. Included in net income and disclosed in the notes to the year-end financial statements.
2. Disclosed only in the notes to the year-end financial statements.
3. Disclosed only in the notes to interim financial statements.
4. Included in net income and disclosed in the notes to interim financial statements.

Answer 21

4. Included in net income and disclosed in the notes to interim financial statements.

Material unusual or infrequent items, and gains or losses from disposal of a component of an entity are (1) separately disclosed in the interim statements, (2) included in interim-period net income, and (3) not prorated over the year.

Question 22

Hyde Corp. has three manufacturing divisions, each of which has been determined to be a reportable operating segment. In Year 4, Clay division had sales of $3 million, which was 25% of Hyde’s total sales, and had traceable operating costs of $1.9 million. In Year 4, Hyde incurred operating costs of $500,000 that were not directly traceable to any of the divisions. In addition, Hyde incurred interest expense of $300,000 in Year 4. The calculation of the measure of segment profit or loss reviewed by Hyde’s chief operating decision maker does not include an allocation of interest expense incurred by Hyde. However, it does include traceable costs. It also includes nontraceable operating costs allocated based on the ratio of divisional sales to aggregate sales. In reporting segment information, what amount should be shown as Clay’s operating profit for Year 4?

$975,000
$900,000
$1,100,000
$875,000

Answer 22

$975,000

Clay’s share of interest expense ($300,000 × 25% = $75,000) is excluded from the calculation of profit.

Given that this measure for Clay reflects traceable costs and an allocation of nontraceable operating costs, the profit is calculated by subtracting the $1,900,000 traceable costs and the $125,000 ($500,000 × 25%) of the allocated costs from the division’s sales of $3,000,000. The profit for the division is $975,000.

Question 23

Andrews Corp.’s $190,000 net income for the quarter ended September 30, Year 6, included the following after-tax items:

In addition, Andrews paid $96,000 on February 1, Year 6, for Year 6 calendar-year property taxes. Of this amount, $24,000 was allocated to the third quarter of Year 6. For the quarter ended September 30, Year 6, Andrews should report net income of

$150,000
$222,000
$206,000
$182,000

Answer 23

$182,000

Gains and losses similar to those that would not be deferred at year-end should not be deferred to later interim periods of the same year. Consequently, the $120,000 gain on disposal of a material operating segment should be recognized in net income for the second quarter. It has no effect on third quarter income. A change in accounting principle is not permitted to take effect in an interim period if it is impracticable to differentiate between the cumulative effect of the change on prior years and the period-specific effects on prior interim periods of the year of the change. Thus, Andrews is not permitted to change this accounting principle until January 1, Year 7. Accordingly, the $32,000 loss should not be included in third quarter income. Because property taxes were proportionally allocated among the four quarters, the $24,000 is properly included in third quarter income. As a result, Andrews should report third quarter net income of $182,000 [$190,000 – ($120,000 ÷ 3) + $32,000].

Question 24

Burr Company had the following account balances at December 31, Year 1:

Cash in banks includes $600,000 of compensating balances related to short-term borrowing arrangements. The compensating balances are not legally restricted as to withdrawal by Burr. In the current assets section of Burr’s December 31, Year 1, balance sheet, total cash should be reported at

$1,775,000
$2,250,000
$2,375,000
$3,975,000

Answer 24

$2,375,000

Legally restricted amounts related to long-term arrangements should be classified separately as noncurrent. Thus, the amount restricted for additions should be classified as noncurrent because it relates to a plant asset. Compensating balances against short-term borrowing arrangements that are legally restricted should be reported separately among the cash and cash equivalents in the current assets section. Total cash reported as current assets therefore equals $2,375,000 ($2,250,000 + $125,000).

Question 25

The following information pertains to Grey Co. at December 31, Year 4:

On Grey’s December 31, Year 4, balance sheet, what amount should be reported as cash?

$12,000
$13,800
$14,200
$16,000

Answer 25

$13,800

The cash account on the balance sheet should consist of (1) coin and currency on hand, (2) demand deposits (checking accounts), (3) time deposits (savings accounts), and (4) near-cash assets (e.g., deposits in transit or checks written to creditors but not yet mailed). Thus, the cash balance should be $13,800 ($12,000 checkbook balance + $1,800 check drawn but not mailed). The checkbook balance is used instead of the bank balance in the calculation. It more closely reflects the amount of cash that is unrestricted at the balance sheet date.

Question 26

Ral Corp.’s checkbook balance on December 31, Year 7, was $5,000. In addition, Ral held the following items in its safe on that date:

The proper amount to be shown as cash on Ral’s balance sheet at December 31, Year 7, is

$4,800
$5,300
$6,500
$6,800

Answer 26

$4,800

The December 31 checkbook balance is $5,000. The $2,000 check dated January 2, Year 8, is properly not included in this balance because it is not negotiable at year end. The $500 NSF check should not be included in cash because it is a receivable. The $300 check that was not mailed until January 10 should be added to the balance. This predated check is still within the control of the company and should not decrease the cash account. Consequently, the cash balance to be reported on the December 31, Year 7, balance sheet is $4,800.

Question 27

Answer 27

Question 28

Fact Pattern:
On January 2, Year 3, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 noninterest-bearing note due January 2, Year 6. There was no established exchange price for the equipment, and the market value of the note cannot be reasonably approximated. The prevailing rate of interest for a note of this type at January 2, Year 3, was 10%. The present value of 1 at 10% for three periods is 0.75.

In Emme’s Year 3 income statement, what amount should be reported as interest income?

$45,000
$60,000
$15,000
$48,000

Answer 28

$45,000

When a noninterest-bearing note is exchanged for property, and neither the note nor the property has a clearly determinable exchange price, the present value of the note should be the basis for recording the transaction. The present value is determined by discounting all future payments using an appropriately imputed interest rate. Emme Co. will receive $600,000 cash in 3 years. Assuming that 10% is the appropriate imputed rate of interest, the present value (initial carrying amount) of the note at January 2, Year 3, was $450,000 ($600,000 × 0.75). Under the interest method, interest income for Year 3 was $45,000 ($450,000 × 10%), and the entry is to debit the discount and credit interest income for that amount.

Question 29

In its December 31 balance sheet, Butler Co. reported trade accounts receivable of $250,000 and related allowance for credit losses of $20,000. What is the total amount of risk of accounting loss related to Butler’s trade accounts receivable, and what amount of that risk is off-balance-sheet risk?

Answer 29

Risk of Accounting Loss = $230,000
Off-Balance- Sheet Risk = $0

Butler’s risk of accounting loss is measured by the net receivables balance ($250,000 accounts receivable – $20,000 allowance for credit losses = $230,000). Accounting loss is the loss that may have to be recognized due to credit and market risk as a direct result of the rights and obligations of a financial instrument.

Question 30

The amount of cash received from the transfer of receivables with recourse is most likely to be reported as a liability under which of the following conditions?

1. The transferor is entitled and obligated to repurchase the receivables at a later date.
2. The transferor is not required to repurchase the receivables except in accordance with limited recourse provisions.
3. Control of the future economic benefits embodied in the receivables has been surrendered by the transferor.
4. A reasonable estimate can be made of the fair value of the obligation of the transferor under the recourse provisions.

Answer 30

1. The transferor is entitled and obligated to repurchase the receivables at a later date.

A transfer of financial assets with recourse is accounted for as a sale if the transferor surrenders control. An example of effective control is an agreement that entitles and obligates the transferor to repurchase or redeem the transferred assets prior to maturity. If the control criteria are not met, the transferor and transferee account for a transfer with recourse as a secured borrowing with a pledge of collateral.

Question 31

Ace Co. sold to King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows:

What should be the total interest revenue earned by King on this note?

$8,000
$5,561
$9,000
$5,050

Answer 31

$5,561

The equal annual payment based on the terms of the note was $5,010 ($20,000 ÷ 3.992 PV of an ordinary annuity for five periods at 8%). However, the note was discounted at 9%. Thus, the amount King must have paid for the note was the present value of the periodic payments discounted at 9%, or $19,489 ($5,010 × 3.89 PV of an ordinary annuity for five periods at 9%). Total interest revenue earned by King was therefore $5,561 [(5 payments × $5,010) – $19,489 cash paid].

Question 32

Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:

Marr uses 3% of accounts receivable to determine its allowance for credit losses at year end. By what amount should Marr adjust its allowance for credit losses at year end?

$40,000
$90,000
$0
$140,000

Answer 32

$40,000

The entity uses the percentage of accounts receivable method to estimate the allowance. The year-end balance should be $90,000 ($3,000,000 A/R × 3%). Hence, the year-end adjustment is $40,000 ($90,000 – $50,000) unadjusted balance.

Question 33

When the allowance method of recognizing credit losses on accounts receivable is used, the entry to record the write-off of a specific account

1. Decreases both accounts receivable and the allowance for credit losses.
2. Decreases accounts receivable and increases the allowance for credit losses.
3. Decreases both accounts receivable and net income.
4. Increases the allowance for credit losses and decreases net income.

Answer 33

1. Decreases both accounts receivable and the allowance for credit losses.

When an account receivable is written off, both accounts receivable and the allowance for credit losses are decreased. The journal entry is to debit the allowance and credit accounts receivable.

Question 34

Gar Co. factored its receivables without recourse with Ross Bank. Gar received cash as a result of this transaction, which is best described as a

1. Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts retained by Gar.
2. Loan from Ross to be repaid by the proceeds from Gar’s accounts receivable.
3. Loan from Ross collateralized by Gar’s accounts receivable.
4. Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts transferred to Ross.

Answer 34

4. Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts transferred to Ross.

When receivables are factored without recourse, the transaction is treated as a sale and the buyer accepts the risk of collectibility. The seller bears no responsibility for credit losses. A sale without recourse is not a loan. In a sale without recourse, the buyer assumes the risk of uncollectible accounts.

Question 35

Bee Co. uses the direct write-off method to account for uncollectible accounts receivable. During an accounting period, Bee’s cash collections from customers equal sales adjusted for the addition or deduction of the following amounts:

Answer 35

Accounts Written Off = Deduction
Increase in Accounts Receivable Balance = Deduction

The direct write-off method debits bad debt expense and credits accounts receivable when an account is written off. Sales are recorded by a debit to accounts receivable or cash and a credit to sales. Accordingly, in the reconciliation of sales to cash collections, an increase in accounts receivable reflects sales without collections. Write-offs of accounts receivable likewise represent sales without collections. Consequently, the increase in accounts receivable and the accounts written off are deductions in reconciling sales to cash collections.

Question 36

The following accounts were abstracted from Roxy Co.’s unadjusted trial balance at December 31:

Roxy estimates that 3% of the gross accounts receivable will become uncollectible. After adjustment at December 31, the allowance for credit losses should have a credit balance of

$30,000
$90,000
$82,000
$38,000

Answer 36

$30,000

The allowance for credit losses at year end should have a credit balance of $30,000. This amount is equal to the $1 million of accounts receivable multiplied by the 3% that are estimated to become uncollectible.

Question 37

On August 15, Benet Co. sold goods for which it received a note bearing the market rate of interest on that date. The 4-month note was dated July 15. Note principal, together with all interest, is due November 15. When the note was recorded on August 15, which of the following accounts increased?

Interest revenue.
Prepaid interest.
Interest receivable.
Unearned discount.

Answer 37

Interest receivable.

Because the note bears interest at a reasonable rate (in this case, the market rate), its present value at the date of issuance is the face amount. Accordingly, the note should be recorded at this amount. Interest receivable also may be debited, and unearned interest revenue may be credited. The simple alternative is to debit cash and credit interest revenue when payment is received. If the reporting period ends prior to November 15, the period-end entry is to debit interest receivable and credit accrued interest revenue.

Question 38

On December 31, Jet Co. received two $10,000 notes receivable from customers in exchange for services rendered. On both notes, interest is calculated on the outstanding principal balance at the annual rate of 3% and payable at maturity. The note from Hart Corp., made under customary trade terms is due in 9 months and the note from Maxx, Inc., is due in 5 years. The market interest rate for similar notes on December 31 was 8%. The compound interest factors to convert future values into present values at 8% follow:

Present value of $1 due in 9 months .944
Present value of $1 due in 5 years .680

At what amounts should these two notes receivable be reported in Jet’s December 31 balance sheet?

Answer 38

Hart = $10,000
Maxx = $7,820

The 3% rate on the Maxx note is unreasonable in light of the prevailing 8% rate for similar notes. This 5-year note should therefore be discounted at an imputed rate of 8%. Because annual interest on the principal is to be paid at maturity, the lump-sum payment due in 5 years is $11,500 {$10,000 + [5 years × ($10,000 × 3%) interest]}. The present value of this amount is $7,820 ($11,500 × .680). However, present-value accounting does not apply to receivables from customers arising in the normal course of business that are due in customary trade terms not exceeding approximately 1 year. Thus, in practice, the Hart note is most likely to be reported at its face amount ($10,000).

Question 39

West Retailers purchased merchandise with a list price of $20,000, subject to trade discounts of 20% and 10%, with no cash discounts allowable. West should record the cost of this merchandise as

$15,600
$20,000
$14,000
$14,400

Answer 39

$14,400

When inventory is subject to cash discounts, the purchases may be reflected either net of these discounts or at the gross prices. However, purchases should always be recorded net of trade discounts. A chain discount is the application of more than one trade discount to a list price. Chain discounts should be applied in steps as indicated below.

Question 40

When the allowance method of recognizing credit losses on accounts receivable is used, how would the collection of an account previously written off affect gross accounts receivable and the allowance for credit losses?

Answer 40

Gross Accounts Receivable = No effect
Allowance for Credit Losses = Increase

When an account that was previously written off that was not expected to be recovered is subsequently collected, the journal entry is to debit (increase) cash and credit (increase) allowance for credit losses. Thus, gross accounts receivable is not affected.

Question 41

In its December 31, Year 3, balance sheet, Fleet Co. reported accounts receivable of $100,000 before allowance for credit losses of $10,000. Credit sales during Year 4 were $611,000, and collections from customers, excluding recoveries, totaled $591,000. During Year 4, accounts receivable of $45,000 were written off and $17,000 were recovered. Fleet estimated that $15,000 of the accounts receivable at December 31, Year 4, were uncollectible. In its December 31, Year 4, balance sheet, what amount should Fleet report as accounts receivable before allowance for credit losses?

$82,000
$75,000
$67,000
$58,000

Answer 41

$75,000

The ending balance in accounts receivable consists of the beginning balance, plus credit sales, minus collections, and minus write-offs. The recovery of accounts that were previously written off does not affect the accounts receivable balance.

Question 42

A company entered into a loan with a lender for $100,000 and pledged $120,000 of the company’s accounts receivable as collateral. The lender does not have the right to sell or repledge the accounts receivable. When the company receives the cash for the loan proceeds, what entry, if any, should be made to accounts receivable?

Credit accounts receivable $20,000.
Credit accounts receivable $100,000.
Credit accounts receivable $120,000.
No entry is made to accounts receivable.

Answer 42

No entry is made to accounts receivable.

A pledge is the use of receivables as collateral (security) for a loan. The borrower agrees to use collections of receivables to repay the loan. Only upon default can the lender sell the receivables to recover the loan proceeds. Because a pledge is a relatively informal arrangement, it is not reflected in the accounts.

Question 43

On April 1, Aloe, Inc., factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?

$68,400
$68,000
$72,000
$76,000

Answer 43

$68,000

Factoring is a transfer of receivables to a third party (a factor) who assumes the responsibility of collection. Factoring discounts receivables on a nonrecourse, notification basis. If a sale is without recourse, the transferee (the factor) assumes the risks and rewards of collection. The factor retained 10% of the receivables ($80,000 × 10% = $8,000) as a reserve (an allowance for returns) and charged a 5% commission on the gross receivables ($80,000 × 5% = $4,000). Accordingly, the transferor received $68,000 ($80,000 – $8,000 – $4,000).

Question 44

Foster Co. adjusted its allowance for credit losses at year end. The general ledger balances for the accounts receivable and the related allowance account were $1,000,000 and $40,000, respectively. Foster uses the percentage-of-receivables method to estimate its allowance for credit losses. Accounts receivable were estimated to be 5% uncollectible. What amount should Foster record as an adjustment to its allowance for credit losses at year end?

$10,000 decrease.
$50,000 decrease.
$10,000 increase.
$50,000 increase.

Answer 44

$10,000 increase.

Because the percentage of accounts receivable method is used to estimate the allowance, the accounts receivable balance must be multiplied by 5%. Thus, the allowance for credit losses should be $50,000 ($1,000,000 × 5%). Given that the pre-adjustment allowance for credit losses is $40,000, the year-end adjustment must increase the allowance by $10,000 (debit credit loss expense, credit the allowance).

Question 45

The following information relates to Jay Co.’s accounts receivable for the year just ended:

What amount should Jay report for accounts receivable, before allowance for credit losses, at December 31?

$1,165,000
$1,085,000
$1,125,000
$1,200,000

Answer 45

$1,085,000

The ending balance in accounts receivable consists of the $650,000 beginning debit balance, plus debits for $2,700,000 of credit sales, minus credits for $2,150,000 of collections, $40,000 of accounts written off, and $75,000 of sales returns.

The $110,000 of estimated uncollectible receivables is not relevant because it affects the allowance account but not gross accounts receivable.

Question 46

Which of the following is a false statement about balance sheet disclosure of accounts receivable?

1. That portion of installment accounts receivable from customers which falls due more than 12 months from the balance sheet date usually would be excluded from current assets.
2. Trade receivables are best shown separately from nontrade receivables where amounts of each are material.
3. Allowances may be deducted from the gross amount of accounts receivable for credit losses and adjustments to be made in the future on accounts shown in the current balance sheet.
4. Accounts receivable should be identified on the balance sheet as pledged if they are used as security for a loan even though the loan is shown on the same balance sheet as a liability.

Answer 46

1. That portion of installment accounts receivable from customers which falls due more than 12 months from the balance sheet date usually would be excluded from current assets.

Current assets are reasonably expected to be realized in cash or to be sold or consumed within 12 months or the operating cycle of the business, whichever is longer. If the ordinary trade receivables of the business fall due more than 12 months from the balance sheet date, then the operating cycle is clearly longer than 12 months and the receivables should be included in current assets.

Question 47

During the year, Hauser Co. wrote off a customer’s account receivable. Hauser used the allowance method for credit losses on accounts receivable. What impact would the write-off have on net income and total assets?

Answer 47

Net Income = No effect
Total Assets = No effect

When using the allowance method, accounts that are written off are charged to the allowance account. The write-off of a particular bad debt has no effect on expenses and net income. Furthermore, write-offs do not affect the carrying amount of net accounts receivable because the reductions of gross accounts receivable and the allowance are the same.