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1

On October 1, 2004, Shaw Corp. purchased a machine for $126,000 that was placed in service on November 30, 2004. Shaw incurred additional costs for this machine, as follows:
Shipping $ 3,000
Installation 4,000
Testing 5,000
In Shaw's December 31, 2004 Balance Sheet, the machine's cost should be reported as:

A. $126,000
B. $129,000
C. $133,000
D. $138,000

D. $138,000

2

Land was purchased to be used as the site for the construction of a plant. A building on the property was sold and removed by the buyer so that construction on the plant could begin.
The proceeds from the sale of the building should be:

A. Classified as other income.
B. Deducted from the cost of the land.
C. Netted against the costs to clear the land and expensed as incurred.
D. Netted against the costs to clear the land and amortized over the life of the plant.

B. Deducted from the cost of the land.

The proceeds from the building removed and sold reduce the cost of the land to the buyer. Had the building been razed, the net razing cost would be added to the land. Compared to the latter situation, the case in the problem results in a cost savings.

3

On December 1, 2005, East Co. purchased a tract of land as a factory site for $300,000. The old building on the property was razed and salvaged materials resulting from demolition were sold.
Additional costs incurred and salvage proceeds realized during December 2005 were as follows:

Cost to raze old building $25,000
Legal fees for purchase contract and to record ownership 5,000
Title guarantee insurance 6,000
Proceeds from sale of salvaged materials 4,000

In East's December 31, 2005 Balance Sheet, what amount should be reported as land?
A. $311,000
B. $321,000
C. $332,000
D. $336,000

C. $332,000
The correct answer, $332,000, equals: $300,000 + $25,000-$4,000 + $5,000 + $6,000.
The net cost to raze the old building ($21,000) is capitalized to land because it is a cost necessary to bring the land into its intended condition. The legal fees and title guarantee cost, likewise, must be incurred to avoid future legal problems, and thus contribute to the value of the land.

4

Lano Corp.'s forestland was condemned for use as a national park. Compensation for the condemnation exceeded the forestland's carrying amount. Lano purchased similar, but larger, replacement forestland for an amount greater than the condemnation award.
As a result of the condemnation and replacement, what is the net effect on the carrying amount of the forestland reported in Lano's Balance Sheet?

A. The amount is increased by the excess of the replacement forestland's cost over the condemned forestland's carrying amount.
B. The amount is increased by the excess of the replacement forestland's cost over the condemnation award.
C. The amount is increased by the excess of the condemnation award over the condemned forestland's carrying amount.
D. No effect, because the condemned forestland's carrying amount is used as the replacement forestland's carrying amount.

A. The amount is increased by the excess of the replacement forestland's cost over the condemned forestland's carrying amount.

The two transactions are not related. The land account is decreased by the book value of the land condemned and increased by the cost of the land purchased. The relative magnitudes of the book values are shown below:
award > book value of condemned land
cost of new land > award
Therefore: cost of new land > book value of condemned land

Thus, the land is increased by the net amount: cost of new land-book value of old land

5

Derby Co. incurred costs to modify its building and to rearrange its production line. As a result, an overall reduction in production costs is expected. However, the modifications did not increase the building's market value, and the rearrangement did not extend the production line's life.
Should the building modification costs and the production line rearrangement costs be capitalized?

Building modification costs Production line rearrangement costs
Yes No
Yes Yes
No No
No Yes

Yes Yes
The criterion for capitalizing post-acquisition costs is not whether the market value of the overall asset is increased. Rather, the criteria are (1) increase in useful life or (2) increase in productivity or efficiency including cost reduction.
An overall reduction in production costs meets the second criterion. Therefore, both costs are capitalized rather than immediately expensed.

When in doubt, choose Yes Yes.

6

Immediately after a note payable was signed, its present value was $30,000. This note and $20,000 cash were used to acquire a used plant asset at the beginning of the current year. The interest rate implied in the note is 6%. Total interest payments due on the note over its term amount to $4,000. The term exceeds one year. No payments on the note are due during the current year. What amount of interest expense is recognized for the first year (current year) on this note, and what amount is capitalized to the plant asset account?
Interest Expense Capitalized Amount
$1,800 $50,000
$3,000 $50,000
$4,000 $30,000
$0 $50,000

$1,800 $50,000
The interest expense recognized for the first year is .06($30,000) = $1,800.
($50,000 is the capitalized amount but $30,000 was borrowed). Although no interest is paid, interest is accrued, increasing the carrying value of the note. The asset is capitalized at $50,000, the sum of cash down payment and present value of the note. The interest over the note term is not capitalized because it does not assist in the process of placing the asset into its intended condition and location.

7

A plant asset under construction by a firm for its own use was completed at the end of the current year. The following costs were incurred:
Materials $60,000
Labor 30,000
Incremental overhead 10,000
Capitalized interest 20,000
The asset has a service life of 10 years, estimated residual value of $10,000, and will be depreciated under the double declining balance method. At completion, the asset was worth $105,000 at fair value. What amount of depreciation will be recognized on the asset in total over its service life?

A. $105,000
B. $120,000
C. $95,000
D. $90,000

C. $95,000
The sum of the four listed costs is $120,000, which exceeds fair value of $105,000. Therefore, the asset is capitalized at $105,000, the lesser of the two amounts. Subtracting the $10,000 residual value yields $95,000 depreciable cost-the total depreciation over the life of the asset.

8

A firm began the construction of its new manufacturing facility in January of 20x2. The following expenditures were made on construction in that year:
Jan. 1 $40,000
Mar. 1 120,000
Oct. 31 96,000
Debt outstanding the entire year:

6%, $60,000 construction loan
4%, $90,000 note payable not related to construction
6%, $90,000 note payable not related to construction
Compute interest to be capitalized using the weighted average method.

A. $6,720
B. $12,600
C. $8,400
D. $8,190

D. $8,190
Average accumulated expenditures is $156,000 = $40,000 + $120,000(10/12) + $96,000(2/12). This method uses the average interest rate on all interest bearing debt, weighted by principal. That rate is the quotient of the interest on all the debt divided by the principal on all the debt. The rate = ($3,600 + $3,600 + $5,400)/$240,000 = .0525. Interest capitalized = (.0525)$156,000. $8,190.

9

Sun Co. was constructing fixed assets that qualified for interest capitalization. Sun had the following outstanding debt issuances during the entire year of construction:
$6,000,000 face value, 8% interest.

$8,000,000 face value, 9% interest.

None of the borrowings were specified for the construction of the qualified fixed asset. Average expenditures for the year were $1,000,000. What interest rate should Sun use to calculate capitalized interest on the construction?

A. 8.00%
B. 8.50%
C. 8.57%
D. 9.00%

C. 8.57%
Neither debt issuances were identified as the construction loan. Therefore, the interest rate must be determined based on the weighted average of the interest on all of the debt outstanding during the year. The calculation is as follows:
$6,0000,000 x .08 = $480,000
$8,000,000 x .09 = $720,000
Totals $14,000,000 $1,200,000
$1,200,000 / $14,000,000 = 8.57%

10

During 2004, Bay Co. constructed machinery for its own use and for sale to customers. Bank loans financed these assets both during construction and after construction was complete.
How much of the interest incurred should be reported as interest expense in the 2004 Income Statement?

Interest incurred for machinery for own use Interest incurred for machinery held for sale
All interest incurred All interest incurred
All interest incurred Interest incurred after completion
Interest incurred after completion Interest incurred after completion
Interest incurred after completion All interest incurred

Own use:
Interest incurred after completion

Held for sale:
All interest incurred

11

Debt is frequently incurred when plant assets are acquired. For example, debt may be incurred on the purchase of plant assets. Debt may also be incurred during the construction of plant assets. How is the interest in these two cases treated for financial reporting?

Debt for purchase Debt during construction
expense capitalize
expense expense
capitalize capitalize
capitalize expense

Debt for purchase: expense
Debt during construction:
capitalize

Interest on debt incurred when purchasing a plant asset, is incurred after the asset has reached its intended condition and location. Therefore, it is expensed as incurred. Debt incurred during the construction of plant assets is considered avoidable and also incurred before the asset has reached its intended condition and location. Therefore, it is capitalized to the asset in the same way material, labor, and overhead are capitalized. The interest is expensed as part of depreciation during the service life of the asset.

12

Cole Co. began constructing a building for its own use in January 2004. During 2004, Cole incurred interest of $50,000 on specific construction debt and $20,000 on other borrowings. Interest computed on the weighted-average amount of accumulated expenditures for the building during 2004 was $40,000.
What amount of interest cost should Cole capitalize?

A. $20,000
B. $40,000
C. $50,000
D. $70,000

B. $40,000
This question requires no calculation. The answer is given in the question.
Capitalized interest is limited to the interest that would have been avoided had the construction not occurred. This is the amount of interest based on average accumulated expenditures.

13

Average accumulated expenditures for year five on a construction project amounted to $70,000. The total cash invested in the project by the end of year five, was $160,000. During year six, the firm spent another $240,000 (total) on the project, uniformly throughout the year. Compute average accumulated expenditures for year six.
A. $240,000
B. $400,000
C. $190,000
D. $280,000

D. $280,000
Average accumulated expenditures is the amount of debt for the annual period that could have been avoided. In this case, the firm has $160,000 already invested in the project at the beginning of year six. That amount represents $160,000 in debt, that could have been avoided for year six if the firm had not been involved in the construction project. The expenditures during year six were incurred evenly. Average accumulated expenditures therefore = $160,000(12/12) + $240,000/2 = $280,000. Also, [$160,000 + ($160,000 + $240,000)]/2 = $280,000.

14

A building suffered uninsured fire damage. The damaged portion of the building was refurbished with higher quality materials. The cost and related accumulated depreciation of the damaged portion are identifiable. To account for these events, the owner should:
A. Reduce accumulated depreciation equal to the cost of refurbishing.
B. Record a loss in the current period equal to the sum of the cost of refurbishing and the carrying amount of the damaged portion of the building.
C. 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.
D. Capitalize the cost of refurbishing by adding the cost to the carrying amount of the building.

C. 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.

15

Many years after constructing a plant asset, management spent a significant sum on the asset. Which of the following types of expenditures should be capitalized in this instance:
(1) an expenditure for routine maintenance that increases the useful life compared with deferring the maintenance,

(2) an expenditure that increases the useful life of the asset compared with the original estimate assuming normal maintenance at the required intervals,

(3) an expenditure that increases the utility of the asset.

(1) (2) (3)
Yes Yes Yes
No Yes Yes
No No Yes
No Yes No

(1) an expenditure for routine maintenance that increases the useful life compared with deferring the maintenance, No

(2) an expenditure that increases the useful life of the asset compared with the original estimate assuming normal maintenance at the required intervals, Yes

(3) an expenditure that increases the utility of the asset. Yes

16

On January 1, 2005, Brecon Co. installed cabinets to display its merchandise in customers' stores. Brecon expects to use these cabinets for five years.
Brecon's 2005 multi-step Income Statement should include:

A. One-fifth of the cabinet costs in cost of goods sold.
B. One-fifth of the cabinet costs in selling, general, and administrative expenses.
C. All of the cabinet costs in cost of goods sold.
D. All of the cabinet costs in selling, general, and administrative expenses.

B. One-fifth of the cabinet costs in selling, general, and administrative expenses.

17

Ichor Co. reported equipment with an original cost of $379,000 and $344,000 and accumulated depreciation of $153,000 and $128,000, respectively, in its comparative financial statements for the years ended December 31, 2005 and 2004.
During 2005, Ichor purchased equipment costing $50,000 and sold equipment with a carrying value of $9,000.
What amount should Ichor report as depreciation expense for 2005?

A. $19,000
B. $25,000
C. $31,000
D. $34,000

C. $31,000
Net equipment at end of 2004: $344,000-$128,000 = $216,000
Equipment purchase 50,000
Book value of equipment sold (9,000)
Depreciation in 2005 ?
Equals net equipment at end of 2005: $379,000-$153,000 = $226,000

Solving for depreciation yields $31,000 depreciation for 2005.

18

Net income is understated if, in the first year, estimated salvage value is excluded from the depreciation computation when using the
Straight-line method Production or use method
Yes No
Yes Yes
No No
No Yes

Straight-line method Production or use method
Yes Yes

19

On January 2, 2005, Lem Corp. bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each, for total cash payments of $130,000.
The cash-equivalent price of the machinery was $110,000. The machinery has an estimated useful life of 10 years and estimated salvage value of $5,000. Lem uses straight-line depreciation.

In its 2005 Income Statement, what amount should Lem report as depreciation for this machinery?

A. $10,500
B. $11,000
C. $12,500
D. $13,000

A. $10,500
The capitalized cost of the equipment is $110,000, not the total of the cash payments to be made. The latter amount includes interest.
Thus, annual depreciation is $10,500:
($110,000-$5,000)/10.

20

Spiro Corp. uses the sum-of-the-years' digits method to depreciate equipment purchased in January 2003 for $20,000. The estimated salvage value of the equipment is $2,000, and the estimated useful life is four years.
What should Spiro report as the asset's carrying amount as of December 31, 2005?

A. $1,800
B. $2,000
C. $3,800
D. $4,500

C. $3,800
Use purchase amount - acc. depr. not depreciable base - acc. depr.

21

A fixed asset with a five-year estimated useful life and no residual value is sold at the end of the second year of its useful life.
How would using the sum-of-the-years'-digits method of depreciation, instead of the double declining balance method of depreciation, affect a gain or loss on the sale of the fixed asset?

Gain Loss
Decrease Decrease
Decrease Increase
Increase Decrease
Increase Increase

Gain Loss
Decrease Increase

22

South Co. purchased a machine that was installed and placed in service on January 1, 2004 at a cost of $240,000. Salvage value was estimated at $40,000. The machine is being depreciated over 10 years by the double declining balance method. For the year ended December 31, 2005, what amount should South report as depreciation expense?
A. $48,000
B. $38,400
C. $32,000
D. $21,600

B. $38,400
Depreciation in 2004 = $240,000(2/10) = $48,000
Depreciation in 2005 = ($240,000-$48,000)(2/10) = $38,400

The DDB method's rate is always twice the straight-line rate, or 2/useful life. The method does not subtract salvage value when computing depreciation.

23

A depreciable asset has an estimated 15% salvage value. Under which of the following methods, properly applied, would the accumulated depreciation equal the original cost at the end of the asset’s estimated useful life?
Straight-line Double-declining balance
Yes Yes
Yes No
No Yes
No No

Straight-line Double-declining balance
No No

24

On January 1, 1998, Crater, Inc. purchased equipment having an estimated salvage value equal to 20% of its original cost at the end of a 10-year life. The equipment was sold December 31, 2002, for 50% of its original cost.
If the equipment's disposition resulted in a reported loss, which of the following depreciation methods did Crater use?

A. Double declining balance.
B. Sum-of-the-years'-digits.
C. Straight-line.
D. Composite.

C. Straight-line.

25

Cantor Co. purchased a coal mine for $2,000,000. It cost $500,000 to prepare the coal mine for the extraction of the coal. It was estimated that 750,000 tons of coal would be extracted from the mine during its useful life. Cantor planned to sell the property for $100,000 at the end of its useful life. During the current year, 15,000 tons of coal were extracted and sold.
What would Cantor's depletion amount be per ton for the current year?

A. $2.50
B. $2.60
C. $3.20
D. $3.30

C. $3.20
The depletion rate is the sum of the cost incurred to acquire the mineral rights, find the minerals, and develop the site less the salvage value, all divided by the estimated number of units of resource expected to be removed from the site.
The depletion rate per ton is ($2,000,000 + $500,000-$100,000)/750,000 = $3.20. This rate is applied to the units removed each period to determine depletion for that period.

As such, it allocates the total cost of the obtaining and developing the resource to each unit of resource removed.

26

Choose the best association of terms in the natural resources accounting area with the conceptual framework.

A. Successful efforts method-matching.
B. Full costing method-definition of asset.
C. Depletion-fair value accounting.
D. Successful efforts method-definition of asset.

D. Successful efforts method-definition of asset.

27

On January 1, year one, an entity acquires a new piece of machinery for $100,000 with an estimated useful life of 10 years. The machine has a drum that must be replaced every five years and costs $20,000 to replace. Also included in the cost of the machine is an inspection fee of $8,000. Continued operations of the machine requires an inspection every four years after purchase. The company uses the straight-line method of depreciation. Under IFRS what is the depreciation expense for year one?
A. $10,000
B. $10,800
C. $12,000
D. $13,200

D. $13,200
Under IFRS the components of the asset must be depreciated over their estimated useful life. Therefore, the $100,000 cost is broken down into the following components:
Depreciable value Life Depreciation
$72,000 10 yr. $7,200
20,000 5 yr. 4,000
8,000 4 yr. 2,000
$13,200

28

Pear Co.'s Income Statement for the year ended December 31, 2004, as prepared by Pear's controller, reported income before taxes of $125,000. The auditor questioned the following amounts that had been included in income before taxes:

Equity in earnings of Cinn Co. $40,000
Dividends received from Cinn 8,000
Adjustments to profits of prior years for arithmetical errors in depreciation (35,000)
Pear owns 40% of Cinn's common stock. Pear's December 31, 2004, Income Statement should report income before taxes of:

A. $85,000
B. $117,000
C. $120,000
D. $152,000

D. $152,000
Income before adjustment $ 125,000
Less dividends from Cinn (8,000)
Plus adjustment for errors 35,000
Equals correct pretax income $ 152,000
Pear uses the equity method to account for its investment in Cinn. Thus, the equity in earnings of Cinn are properly included in Pear earnings.

However, the dividends are removed from income because under the equity method dividends reduce the investment account. They are not included in income. The error adjustments were subtracted from income but are actually prior period adjustments. These are adjustments to retained earnings and do not affect income. Thus, the adjustments are added back to income.

29

Stock dividends on common stock should be recorded at their fair market value by the investor when the related investment is accounted for under which of the following methods?
Cost Equity
Yes Yes
Yes No
No Yes
No No

Cost Equity
No No

The receipt of a stock dividend is not recognized in the accounts, at fair value or any other amount. The cost basis of the stock is reduced because the original cost is spread over more shares.

30

When the equity method is used to account for investments in common stock, which of the following affects the investor's reported investment income?
Goodwill amortization related to purchase Cash dividends from investee
Yes Yes
No Yes
No No
Yes No

Goodwill amortization related to purchase Cash dividends from investee
No No

31

Bort Co. purchased 2,000 shares of Crel Co. common stock on March 5, 2004 for $72,000.
Bort received a $1,000 cash dividend on the Crel stock on July 15, 2004. Crel declared a 10% stock dividend on December 15, 2004, to stockholders of record as of December 31, 2004. The dividend was distributed on January 15, 2005. The market price of the stock was $38 on December 15, 2004, $40 on December 31, 2004, and $42 on January 15, 2005.

What amount should Bort record as dividend revenue for the year ended December 31, 2004?

A. $1,000
B. $8,600
C. $9,000
D. $9,400

A. $1,000
Only cash or property dividends are recognized as income to the recipient. Stock dividends are not recognized as revenue. Therefore dividend revenue is $1,000.
A stock dividend increases the number of shares for each investor, but not their percentage of the firm. After a 10% stock dividend, all investors hold 10% more stock but each share should be worth less (in theory).
GAAP does not record any value for a stock dividend received although the cost per share decreases and, thus, the gain per share on subsequent sale is increased.

32

Which, if any, of the following characteristics concerning the categories of investments under IFRS No. 9 is/are correct?
I. There is a single category for debt investments and a single category for equity investments.

II. The business model test used in evaluating debt instruments for classification purposes is concerned with the investor's intent.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

B. II only.

Single category for equity instruments, but two categories for debt investments (at amortized cost and FV).

33

Jacko, Co., a 50% owner of Venture Co., a jointly controlled entity, contributed to Venture a nonmonetary asset with an original cost of $200,000, accumulated depreciation of $50,000, and a fair value of $180,000. Under IFRS, which one of the following is the amount of gain, if any, Jacko should recognize on its contribution to Venture Co.?
A. $ 0 (no gain)
B. $15,000
C. $20,000
D. $30,000

B. $15,000
A gain should be recognized by Jacko for the share of ownership held by others (50%) attributable to the excess of the fair value of the asset over its carrying value. The excess of fair value ($180,000) over carrying value ($200,000-$50,000 = $150,000) is $30,000 ($180,000- $150,000). Therefore, Jacko should recognize .50 x $30,000 = $15,000 as a gain.

34

On January 1, 2004, Purl Corp. purchased, as a long-term investment, $500,000 face value Shaw, Inc. 8% bonds for $456,200. The bonds were purchased to yield 10% interest. Purl has the positive intent and ability to hold the bonds until maturity on January 1, 2010. The bonds pay interest annually on January 1, and Purl uses the interest method of amortization.
What amount (rounded to nearest $100) should Purl report on its December 31, 2005 Balance Sheet for this long-term investment?

A. $468,000
B. $466,200
C. $461,800
D. $456,200

A. $468,000
A held-to-maturity (HTM) investment purchased at a discount increases in value as maturity approaches, at which time the book value of the investment must be the face value of the investment. During the life of an HTM investment the investor carries and reports the investment at amortized cost.

The interest and amortization entries for the two years 2004 and 2005 lead to the correct ending balance at December 31, 2005 are:

December 31, 2004:

Interest receivable .08($500,000) 40,000
Investment in HTM bonds 5,620
Interest revenue .10($456,200) 45,620
December 31, 2005:

Interest receivable .08($500,000) 40,000
Investment in HTM bonds 6,182
Interest revenue .10($456,200 + $5,620) 46,182

35

Which, if any, of the following statements concerning disclosures related to investment property is/are correct?
I. When the fair value method is used, the entity must disclose whether or not a qualified independent party provided valuations.

II. When the cost method is used, the entity must still disclose fair value of investment property.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.
Both Statement I and Statement II are correct. When the fair value method is used to measure investment property, the entity must disclosed whether or not a qualified independent party provided valuations, (Statement I) and when the cost method is used to measure investment property, the entity must disclose fair value of investment property (Statement II).

36

The credit losses associated with the impairment of debt securities are separated in which of the following circumstances?
A. When the entity has the positive ability and intent to sell the impaired security.
B. When the entity has the positive ability and intent to hold the impaired security.
C. When the entity has positive ability and intent to hold the impaired security and expects to recover the entire cost basis of the impaired security.
D. When the entity has positive ability and intent to hold the impaired security and does not expect to recover the entire cost basis of the impaired security.

D. When the entity has positive ability and intent to hold the impaired security and does not expect to recover the entire cost basis of the impaired security.

37

A marketable equity security is transferred from the held for trading portfolio to the available-for-sale portfolio. At the transfer date, the security's cost exceeds its market value.
What amount is used at the transfer date to record the security in the available-for-sale portfolio?

A. Market value, regardless of whether the decline in market value below cost is considered permanent or temporary.
B. Market value, only if the decline in market value below cost is considered permanent.
C. Cost, if the decline in market value below cost is considered temporary.
D. Cost, regardless of whether the decline in market value below cost is considered permanent or temporary.

A. Market value, regardless of whether the decline in market value below cost is considered permanent or temporary.
Reclassifications between the two investment categories are always recorded at market value. The reclassification is treated as if the security in the old classification was sold, and the security in the new classification was purchased.
Market value reflects a brand new valuation and is treated as original cost from then on for the purpose of the annual year-end revaluation adjustment.

38

Which of the following is not a factor to take into consideration when determining if the decline in fair value of an equity security is other-than-temporary?
A. The length of time and extent to which the market value has been less than cost.
B. The length of time the holder has held the security.
C. The financial condition and near term prospects of the issuer.
D. The intent and ability of the holder to retain its investment for a period of time to allow for any anticipated recovery in the market value.

B. The length of time the holder has held the security.

The question asks which is not a factor related to the determination of OTTI. The financial condition and near term prospects of the issuer is a factor.

39

Which of the following statements is true concerning the correct accounting for most investments?
I. An investor must account for (measure) most investments using fair value.
II. An investor may elect to account for (measure) some investments at fair value.
A. I. only.
B. II. only.
C. Both I. and II.
D. Neither I. nor II.

B. II. only.
An investor may elect to use fair value to account for or measure some investments that otherwise would be accounted for using amortized cost or the equity method (Statement II). However, an investor is not required to use fair value to account for most investments (Statement I).

40

Which one of the following is not considered an equity investment for investment accounting purposes?
A. Common stock warrants.
B. Preferred stock.
C. Redeemable preferred stock.
D. Common stock options.

C. Redeemable preferred stock.
Redeemable preferred stock is not considered an equity security for investment accounting purposes. Redeemable preferred stock, also known as callable preferred stock, may be reacquired by the issuing corporation under prescribed conditions.

41

For accounting purposes, how many levels of influence, that an investor may have over an investee, are identified?
A. One.
B. Two.
C. Three.
D. Four.

C. Three.
Accounting identifies three levels of influence that an investor may have over an investee. Those levels are: (1) no significant influence, (2) significant influence, but not control, and (3) control.

42

Which one of the following is least likely to be a factor in determining how an investment in debt or equity securities is accounted for and reported in financial statements?
A. The nature of the investment.
B. The method of payment used to acquire the investment.
C. The extent or proportion of the investment securities acquired.
D. The purpose for which the investment was made.

B. The method of payment used to acquire the investment.
The method of payment used to acquire an investment does not help determine the correct accounting treatment of the investment. While the method of payment determines what will be "credited" upon acquisition of the securities, it will not enter into the subsequent accounting treatment of the investment.

43

Which, if either, of the following statements concerning the transfer of investments between categories under IFRS No. 9 is/are correct?
I. Only investments in debt securities may be transferred between categories.

II. When investments are transferred between categories, financial statements of prior periods presented for comparative purposes must not be restated.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

A. I only.
Statement I is correct; Statement II is not correct. Only investments in debt securities may be transferred between categories; equity securities may not be transferred between categories (Statement I). When investments are transferred between categories, financial statements of prior periods presented for comparative purposes must be restated (Statement II).

44

Which, if any, of the following transfers between categories is possible under IFRS No. 9 for investments in debt securities?
Amortized cost to fair value Fair value to amortized cost
Yes Yes
Yes No
No Yes
No No

Yes Yes
Under IFRS No. 9, investments in debt securities may be (1) transferred from amortized cost (when the investment originally meets both the business model test and the cash flow characteristic test) to fair value when the investment fails to continue to meet both the business model test and the cash flow characteristic test and (2) transferred from fair value to amortized cost when an investment that originally fails to meet both the business model test and the cash flow characteristic test subsequently meets both tests.

45

Inco, Inc., a U.S. entity, has elected to prepare financial statements in accordance with IFRS to provide to its foreign suppliers. Inco has the following information concerning an investment in the bonds of Tryco, Inc., as of December 31, 2011:
Par value $100,000
Original cost 108,000
Current premium 3,500
Fair value 105,000
Inco normally does not invest in debt but made this investment with the expectation that it could profit from short-term decreases in the market interest rate. Which one of the following is the amount at which Inco should report its investment in Tryco in its December 31, 2011 IFRS-based Statement of Financial Position?

A. $100,000
B. $103,500
C. $105,000
D. $108,000

C. $105,000
Under IFRS No. 9, investments in debt securities that are not made under an entity's business model plan to make and hold such investments solely to receive cash flow from interest and principal repayment should be reported at fair value. Thus, this investment should be reported at the fair value, $105,000.

46

Inco, Inc., a U.S. entity, has elected to prepare financial statements in accordance with IFRS to provide to its foreign suppliers. Inco has the following information concerning an investment in the bonds of Tryco, Inc., as of December 31, 2011:
Par value $100,000
Original cost 108,000
Current premium 3,500
Fair value 105,000
Inco's business model is to regularly invest in debt to receive the cash flow provided by interest and the repayment of principal on maturity. The bonds are not associated with any other asset or liability. Which one of the following is the amount at which Inco should report its investment in Tryco in its December 31, 2011 IFRS-based Statement of Financial Position?

A. $100,000
B. $103,500
C. $105,000
D. $108,000

B. $103,500
Under IFRS No. 9, investments in debt securities made under an entity's business model plan to make and hold such investments solely to receive cash from interest and principal repayment, and when there is no accounting mismatch, should be reported at amortized cost. Amortized cost is par value ($100,000) plus the unamortized premium ($3,500), or $100,000 + $3,500 = $103,500, the correct answer.

47

The method of accounting for investments that does not give the investor significant influence over the investee is based on the investor's intent in making the investment. When investor intent changes, the classification of and accounting for the investment changes. When investments are transferred between classifications, which one of the following valuation basis is most likely to be used when recording the investment in the new classification?
A. Historic cost.
B. Amortized cost.
C. Prior carrying value.
D. Fair market value.

D. Fair market value.

48

Which, if any, of the following transfers between classifications of investments (which do not give the investor significant influence) are possible?
Held-to-maturity to held-for-trading Held-for-trading to held-to-maturity
Yes Yes
Yes No
No Yes
No No

Held-to-maturity to held-for-trading Held-for-trading to held-to-maturity
Yes Yes
Both transfers from held-to-maturity to held-for-trading classifications and from held-for-trading to held-to-maturity classifications can occur in the accounting for investments where the investor does not have significant influence over the investee.

49

Sun Corp. had investments in marketable equity securities costing $650,000. On June 30, 20x2, Sun decided to hold the investments indefinitely and, accordingly, reclassified them from held-for-trading to available-for-sale on that date. The investments' market value was $575,000 at December 31, 20x1, $530,000 at June 30, 20x2, and $490,000 at December 31, 20x2.
What amount should Sun report as net unrealized loss on noncurrent marketable equity securities in its 20x2 statement of stockholders' equity?

A. $40,000
B. $45,000
C. $85,000
D. $160,000

A. $40,000
The securities were classified as available-for-sale at June 30, 20x2. The decline in market value from that date to December 31, 20x2 is $40,000 ($530,000-$490,000).
That amount is reported in owners' equity because holding gains and losses on securities available-for-sale are not recognized in earnings.

50

For a marketable-equity securities portfolio classified as available-for-sale, which of the following amounts should be included in the period's net income?

I. Unrealized temporary losses during the period.

II. Realized gains during the period.

III. Changes in the valuation allowance during the period.

A. III only.
B. II only.
C. I and II.
D. I, II, and III.

B. II only.
On available-for-sale securities, only realized gains (from sale or reclassification) are recognized in the period.
These securities are not sold for the purpose of relatively quick sale. Rather, they are held for different purposes and may be held long-term. The unrealized changes in market value are recorded in owners' equity.

51

On July 1, 2004, York Co. purchased, as a held-to-maturity investment, $1,000,000 of Park, Inc.'s 8% bonds for $946,000, including accrued interest of $40,000.
The bonds were purchased to yield 10% interest. The bonds mature on January 1, 2011 and pay interest annually on January 1. York uses the effective interest method of amortization.

In its December 31, 2004 Balance Sheet, what amount should York report as investment in bonds?

A. $911,300
B. $916,600
C. $953,300
D. $960,600

A. $911,300
Initial investment cost: $946,000-$40,000 =
$906,000
Interest revenue for 2004: $906,000(.10)(1/2 year) = $45,300
Less cash interest for 6 months: $1,000,000(.08)(1/2) = (40,000)
Equals amortization of discount (increases investment)
5,300
Investment in bonds balance at the end of 2004
$911,300

The book value of the bond investment at maturity will be $1,000,000. Thus, the discount amortization increases the investment carrying value each year until it reaches $1,000,000.

52

An investor purchased a bond classified as a held-to-maturity investment between interest dates at a discount.
At the purchase date, the carrying amount of the bond is more than the:

Cash paid to seller Face amount of bond
No Yes
No No
Yes No
Yes Yes

No No
When a bond is purchased at a discount, the price paid is less than face value. Any cash paid to the seller for accrued interest is debited to interest receivable, not to the bond investment. Thus, the carrying value is the portion of the total amount paid attributable to the total bond price, exclusive of accrued interest.
The carrying value must be less than the cash paid to the seller, which includes accrued interest.

53

On October 1, 2004, Park Co. purchased 200 of the $1,000 face value, 10% bonds of Ott, Inc., for $220,000, including accrued interest of $5,000.
The bonds, which mature on January 1, 2011, pay interest semiannually on January 1 and July 1. Park used the straight-line method of amortization and appropriately recorded the bonds as held-to-maturity.
On Park's December 31, 2005 Balance Sheet, the bonds should be reported at:

A. $215,000
B. $214,400
C. $214,200
D. $212,000

D. $212,000

$220,000 cash price
- 5,000 accrued interest
215,000 purchase price
- 200,000 par value
= 15,000 prem./(disc.)

215,000 purchase price
-(15,000/75)*15 = 212,000
(premium/term of holding bonds)*period from purchase to what question asks for = B/S reporting amount

Therefore, the ending 12/31/05 investment carrying value is $212,000 = $215,000-($15,000/75)15.

54

On both December 31, 2003 and December 31, 2004, Kopp Co.'s only marketable equity security had the same market value, which was below cost.
Kopp considered the decline in value to be temporary in 2003 but other than temporary in 2004. At the end of both years, the security was classified as a noncurrent available-for-sale investment.

What should be the effects of the determination that the decline was other than temporary on Kopp's 2004 net noncurrent assets and net income?

A. No effect on both net noncurrent assets and net income.
B. No effect on net noncurrent assets and decrease in net income.
C. Decrease in net noncurrent assets and no effect on net income.
D. Decrease in both net noncurrent assets and net income.

B. No effect on net noncurrent assets and decrease in net income.

A permanent decline in the value of an available-for-sale security is recognized as a loss in the Income Statement (whereas nonpermanent declines are treated as reductions in owners' equity).

55

On January 1 of the current year, Barton Co. paid $900,000 to purchase two-year, 8%, $1,000,000 face value bonds that were issued by another publicly-traded corporation. Barton plans to sell the bonds in the first quarter of the following year. The fair value of the bonds at the end of the current year was $1,020,000. At what amount should Barton report the bonds in its balance sheet at the end of the current year?
A. $900,000
B. $950,000
C. $1,000,000
D. $1,020,000

D. $1,020,000

For investments in debt securities (including bonds) other than those intended to be held to maturity, the fair value method is applied. $1,020,000 is the fair value of the investment in bonds and is the appropriate amount for reporting the investment.

56

On January 2, 2004, Adam Co. purchased, as a long-term investment, 10,000 shares of Mill Corp.'s common stock for $40 a share.
On December 31, 2004, the market price of Mill's stock was $35 a share, reflecting a temporary decline in market price. On December 28, 2005, Adam sold 8,000 shares of Mill stock for $30 a share.

For the year ended December 31, 2005, Adam should report a loss on disposal of long-term investment of:

A. $100,000
B. $90,000
C. $80,000
D. $40,000

C. $80,000

The realized loss on the sale of available-for-sale securities is the decline in market value since the acquisition of the securities sold. The $80,000 loss equals 8,000($40-$30). The loss to the beginning of 2005 is unrealized and recorded in owners' equity.

57

Pare, Inc. purchased 10% of Tot Co.'s 100,000 outstanding shares of common stock on January 2, 2004, for $50,000.
On December 31, 2004, Pare purchased an additional 20,000 shares of Tot for $150,000. There was no goodwill as a result of either acquisition, and Tot had not issued any additional stock during 2004. Tot reported earnings of $300,000 for 2004.

What amount should Pare report in its December 31, 2004, Balance Sheet as investment in Tot?

A. $170,000
B. $200,000
C. $230,000
D. $290,000

C. $230,000
This question is difficult because it is easy to forget that once the investor has acquired a sufficient percentage of the stock to use the equity method, which is retroactively applied to earlier periods for which the holdings were not sufficient to use the equity method. In these earlier periods, only the actual ownership percentage is applied.
In this question, the equity method becomes the required method only at the very end of the year. So, only the 10% is used in applying the equity method for the purpose of recognizing income, which in turn increases the investment account.

The ending balance of the investment account is then: $50,000 (original investment) + $150,000 (second investment) + $30,000 (.10 x $300,000, which is the equity in earnings of the investee) = $230,000.

58

In its financial statements, Pulham Corp. uses the equity method of accounting for its 30% ownership of Angles Corp. At December 31, 2005, Pulham has a receivable from Angles.
How should the receivable be reported in Pulham's 2005 financial statements?

A. None of the receivable should be reported, but the entire receivable should be offset against Angles' payable to Pulham.
B. Seventy percent of the receivable should be separately reported, with the balance offset against 30% of Angles' payable to Pulham.
C. The total receivable should be disclosed separately.
D. The total receivable should be included as part of the investment in Angles without a separate disclosure.

C. The total receivable should be disclosed separately.

59

Green Corp. owns 30% of the outstanding common stock and 100% of the outstanding noncumulative nonvoting preferred stock of Axel Corp. Green's 30% ownership of common stock gives it significant influence over Axel.
In 2004, Axel declared dividends of $100,000 on its common stock and $60,000 on its preferred stock. Green exercises significant influence over Axel's operations.
What amount of dividend revenue should Green report in its Income Statement for the year ended December 31, 2004?

A. $0
B. $30,000
C. $60,000
D. $90,000

C. $60,000
Only the dividends received on the preferred stock are recognized as revenue: $60,000 = 100% x ($60,000). The common stock investment is accounted for under the equity method, which treats all dividends received as a return of capital. Dividends reduce the investment account under this method.

60

When an investor owns 40% of the voting stock of an investee, and a standstill agreement is executed between the investor and the investee, which of the following is most likely to be used in accounting for the investment?
A. Cost.
B. Fair market value.
C. The lower of cost or fair market value.
D. Equity method of accounting.

B. Fair market value.
Even though the investor owns 40% of the voting stock of an investee, if a standstill agreement exists between the investor and the investee, the investor cannot exercise significant influence over the investee and likely would use fair value to carry and report the investment. A standstill agreement is a written agreement between two firms whereby certain actions between the firms are limited.

61

When an investor acquires sufficient voting common stock of an investee so that it has significant influence, which, if any, of the following kinds of investee data must the investor "capture" at the time the investment is made?
Book values of assets & liabilities FV of A&L
Yes Yes
Yes No
No Yes
No No

Book values of assets & liabilities Fair values of assets & liabilities
Yes Yes

62

Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability to exercise significant influence over Devon. The following information relates to Larkin's investment in Devon during the most recent year:
Carrying amount of Larkin's investment in Devon at the beginning of the year $200,000
Net income of Devon for the year 600,000
Total dividends paid to Devon's stockholders during the year 400,000
What is the carrying amount of Larkin's investment in Devon at year end?

A. $100,000
B. $200,000
C. $250,000
D. $350,000

C. $250,000
Larkin's investment in Devon at year end would be computed as the carrying amount of the investment at the beginning of the year ($200,000) + Larkin's share of Devon's reported net income for the year ($600,000 x .25 = $150,000)-Larkin's share of Devon's dividends paid during the year ($400,000 x .25 = $100,000), or $200,000 + $150,000 = $350,000-$100,000 = $250,000, the correct answer.

63

In its financial statements, Pulham Corp. uses the equity method of accounting for its 30% ownership of Angles Corp. At December 31, 2005, Pulham has a receivable from Angles.
How should the receivable be reported in Pulham's 2005 financial statements?

A. None of the receivable should be reported, but the entire receivable should be offset against Angles' payable to Pulham.
B. Seventy percent of the receivable should be separately reported, with the balance offset against 30% of Angles' payable to Pulham.
C. The total receivable should be disclosed separately.
D. The total receivable should be included as part of the investment in Angles without a separate disclosure.

C. The total receivable should be disclosed separately.

64

Peel Co. received a cash dividend from a common stock investment. Should Peel report an increase in the investment account if it accounts for the investment as held-for-trading or uses the equity method of accounting?
Held-for-trading Equity method
No No
Yes Yes
Yes No
No Yes

No No
A dividend never increases the investment account under any accounting method.
Under the cost method, the dividend is recorded as revenue. Under the equity method, the dividend is recorded as a decrease in the investment account.

65

Pal Corp.'s 2004 dividend income included only part of the dividend received from its Ima Corp. investment. The balance of the dividend reduced Pal's carrying amount for its Ima investment. This reflects that Pal accounts for its Ima investment by the:
A. Fair Value method, and only a portion of Ima's 2004 dividends represent earnings after Pal's acquisition.
B. Fair Value method, and its carrying amount, exceeded the proportionate share of Ima's market value.
C. Equity method, and Ima incurred a loss in 2004.
D. Equity method, and its carrying amount exceeded the proportionate share of Ima's market value.

A. Fair Value method, and only a portion of Ima's 2004 dividends represent earnings after Pal's acquisition.

The portion of the dividend reducing the investment carrying value is a liquidating dividend.

The market value of an investment is not used for any reason under the cost method. The fact that the carrying amount exceeds the market value of the stock has no bearing on the amount of the dividend to be treated as a reduction in the investment balance.

66

According to IFRS guidance on equity method accounting, under what circumstances would the investor be required to recognize the associate's (investee's) losses that exceed the investor's investment?
I. The associate's return to profitability is imminent and assured.

II. The investor has guaranteed the obligations and commitments of the associate.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

B. II only.
If the investor has obligations or commitments to make payments on behalf of the associate, it may continue to recognize its share of losses to the extent of those obligations.

67

Which one of the following is least likely to be used to report an investment in a corporate joint venture?
A. Equity method.
B. Fair Value method.
C. Consolidation basis.
D. Partnership basis.

B. Fair Value method.

68

Which one of the following is the most likely characteristic of a business joint venture?
A. Profits and losses are shared equally.
B. Control is shared jointly by parties to the venture.
C. Must be established for a limited time.
D. Must be formed as a corporation.

B. Control is shared jointly by parties to the venture.

69

On March 4, 2004, Evan Co. purchased 1,000 shares of LVC common stock at $80 per share.
On September 26, 2004, Evan received 1,000 stock rights to purchase an additional 1,000 shares at $90 per share. The stock rights had an expiration date of February 1, 2005. On September 30, 2004, LVC's common stock had a market value, exrights, of $95 per share and the stock rights had a market value of $5 each.

What amount should Evan report on its September 30, 2004, Balance Sheet for investment in stock rights?

A. $4,000
B. $5,000
C. $10,000
D. $15,000

A. $4,000

The original stock investment cost is allocated to the stock and the rights based on their relative market values. Total market value of the stock is $95,000, and of the rights is $5,000. The original cost of the stock is $80,000. Thus the investment in stock rights is reported at [$5,000/($5,000 + $95,000)]*$80,000 = $4,000.

70

Plack Co. purchased 10,000 shares (2% ownership) of Ty Corp. on February 14, 2005.
Plack received a stock dividend of 2,000 shares on April 30, 2005, when the market value per share was $35. Ty paid a cash dividend of $2 per share on December 15, 2005.
In its 2005 Income Statement, what amount should Plack report as dividend income?

A. $20,000
B. $24,000
C. $90,000
D. $94,000

B. $24,000
Because Plack Co. owns only 2% of Ty Corp. stock, it does not have significant influence over Ty and will not use the equity method to account for its investment. Plank's dividend will be determined by the number of shares of Ty that it owns multiplied by the amount of dividend per share. The calculation is:
2/14 Purchase
10,000 shares
4/30 Stock dividend
2,000 shares
12/15 Total shares owned
12,000
Dividend rate
$ 2
Total Dividend Income
$24,000
The stock dividend would be recorded by Plack as a memorandum entry to adjust the per-share original cost, so it is based on the total 12,000 shares now owned.

71

Band Co. uses the equity method to account for its investment in Guard, Inc. common stock. How should Band record a 2% stock dividend received from Guard?
A. As dividend revenue at Guard's carrying value of the stock.
B. As dividend revenue at the market value of the stock.
C. As a reduction in the total cost of Guard stock owned.
D. As a memorandum entry, reducing the unit cost of all Guard stock owned.

D. As a memorandum entry, reducing the unit cost of all Guard stock owned.

72

Which, if either, of the following statements concerning investment property is/are correct?
I. A part of a building may be investment property, while the other part is not investment property.

II. Property leased between affiliated entities cannot be reported as investment property in consolidated statements.

A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.

C. Both I and II.
Both Statement I and statement II are correct. It is correct that a part of a building may be investment property, while the other part is not investment property, if the two parts of property can be separately sold or rented and if the other requirements of investment property are met. It also is correct that property leased between affiliated entities cannot be reported as investment property in consolidated statements because, at the consolidated level, the leased property would be owner-occupied.

73

Which of the following methods used to measure and report investment property will require disclosure of a reconciliation showing the causes of changes in the carrying amounts of investment property, between the beginning and end of a period?
Use of cost method Use of fair value method
Yes Yes
Yes No
No Yes
No No

Use of cost method Use of fair value method
Yes Yes
When either the cost method or the fair value method is used to measure investment property; the entity must provide a reconciliation showing the causes of changes in the carrying amounts of investment property between the beginning and end of a period.

74

Which of the following methods may be used to measure and report investment property?
Fair Value method Cost method
Yes Yes
Yes No
No Yes
No No

Yes Yes
Investment property may be measured using either the fair value method (model) or the cost method (model). Whichever method is selected must be used in accounting for all the investment property of an entity.

75

Which of the following is least likely to be investment property under IFRS?
A. A vacant building listed with a broker as available for lease under an operating lease.
A vacant building listed with a broker and available for lease under an operating lease would qualify as investment property. The apparent purpose of the building is to earn rental income under an operating lease.
B. A plot of vacant land held for long-term capital appreciation.
C. A building under construction that is to be leased upon completion to another entity under an operating lease.
D. A plot of vacant land that is for sale by a land developer.

D. A plot of vacant land that is for sale by a land developer.
A plot of vacant land that is for sale by a land developer would not qualify as investment property. The vacant land would constitute inventory to a land developer and, since it is not being held for capital appreciation, would not qualify as investment property.

76

Firm A purchased Firm B for $4,000 when B's total owners' equity was $2,000. Firm A completed the qualitative test for goodwill impairment and determined that it is more likely than not that goodwill may be impaired. B had one asset worth $500 more than the book value. One year after the purchase, Firm B's total market value had dropped to $3,200 and the market value of its net identifiable assets was $2,000. What amount of goodwill impairment loss is recorded?
A. $0
B. $800
C. $400
D. $300

D. $300

The recorded goodwill is $1,500 (purchase price $4,000-fair market value of net assets $2,500). The goodwill impairment loss is the implied goodwill ($1,200) less the recorded goodwill ($1,500) or $300.

77

A company is completing its annual impairment analysis of the goodwill included in one of its cash generating units (CGUs). The recoverable amount of the CGU is $32,000. The company noted the following related to the CGU:
Goodwill Patents Other assets Total
Historical cost $15,000 $10,000 $35,000 $60,000
Depreciation and amortization 0 3,333 11,667 15,000
Carrying amount, December 31 $15,000 $6,667 $23,333 $45,000
Under IFRS, which of the following adjustments should be recognized in the company's consolidated financial statements?

A. Decrease goodwill by $13,000.
B. Decrease goodwill by $15,000.
C. Decrease goodwill by $3,250; patents by $2,167; and other assets by $7,583.
D. Decrease goodwill by $4,333; patents by $1,926; and other assets by $6,741.

A. Decrease goodwill by $13,000.
Under IFRS goodwill impairment is measured in a one-step process. The carrying value of the CGU is compared to the recoverable amount. If the CV > recoverable amount the goodwill is impaired. The impairment loss is the recoverable amount - the CV. In this case $32,000 - $45,000 = ($13,000) loss.

78

A company recently acquired a copyright that now has a remaining legal life of 30 years. The copyright initially had a 38-year useful life assigned to it. An analysis of market trends and consumer habits indicated that the copyrighted material will generate positive cash flows for approximately 25 years. What is the remaining useful life, if any, over which the company can amortize the copyright for accounting purposes?
A. 0 years.
B. 25 years
C. 30 years
D. 38 years

B. 25 years
This copyright has a definite life; the question is what is the length of that life? The life assigned to the intangible asset is the shorter of its legal and useful life. The useful life is shorter than the legal life, so this copyright is amortized over 25 years.

79

A company should recognize goodwill in its balance sheet at which of the following points?
A. Costs have been incurred in the development of goodwill.
B. Goodwill has been created in the acquisition of a business.
C. The company expects a future benefit from the creation of goodwill.
D. The fair market value of the company's assets exceeds the book value of the company's assets.

B. Goodwill has been created in the acquisition of a business.

Goodwill is recognized and measured at the date of a business acquisition. Goodwill is measured as the difference between the consideration transferred in a business acquisition and the fair market value of the identifiable net assets acquired.

80

An automobile dealer sells service contracts. The contracts stipulate that the dealer will perform specific repairs on covered vehicles. The contracts vary in length from 12 to 36 months.
Do the following increase when service contracts are sold?

Deferred revenue Service revenue
Yes Yes
No No
No Yes
Yes No

Deferred revenue Service revenue
Yes No

81

An entity purchases a trademark and incurs the following costs in connection with the trademark:
One-time trademark purchase price $100,000
Nonrefundable VAT taxes 5,000
Training sales personnel on the use of the new trademark 7,000
Research expenditures associated with the purchase of the new trademark 24,000
Legal costs incurred to register the trademark 10,500
Salaries of the administrative personnel 12,000
Applying IFRS and assuming that the trademark meets all the applicable initial asset-recognition criteria, the entity should recognize an asset in the amount of:

A. $100,000
B. $115,500
C. $146,500
D. $158,500

B. $115,500
The capitalizable costs for an intangible asset under IFRS 38 are essentially the same as U.S. GAAP. The cost of the asset is the cash paid to acquire the asset, including the cost to obtain legal title and control of the asset. This cost will include the purchase price ($100,000), the taxes ($5,000), and the legal costs to register the asset ($10,500).

82

An increase in the cash-surrender value of a life insurance policy owned by a company would be recorded by:
A. Decreasing annual insurance expense.
B. Increasing investment income.
C. Recording a memorandum entry only.
D. Decreasing a deferred charge.

A. Decreasing annual insurance expense.

83

Upon the death of an officer, Jung Co. received the proceeds of a life insurance policy held by Jung on the officer. The proceeds were not taxable. The policy's cash-surrender value had been recorded on Jung's books at the time of payment.
What amount of revenue should Jung report in its statements?

A. Proceeds received.
B. Proceeds received less cash surrender value.
C. Proceeds received plus cash surrender value.
D. None.

B. Proceeds received less cash surrender value.

84

In 2000, Chain, Inc. purchased a $1,000,000 life insurance policy on its president, of which Chain is the beneficiary. Information regarding the policy for the year ended December 31, 2005, follows:

Cash surrender value, 1/1/05
$ 87,000
Cash surrender value, 12/31/05
108,000
Annual advance premium paid 1/1/05
40,000
During 2005, dividends of $6,000 were applied to increase the cash surrender value of the policy. What amount should Chain report as life insurance expense for 2005?

A. $40,000
B. $25,000
C. $19,000
D. $13,000

C. $19,000
Insurance expense is $19,000 ($40,000-$21,000) for 2005.

85

On January 2, 2004, Beal, Inc. acquired a $70,000 whole-life insurance policy on its president. The annual premium is $2,000. The company is the owner and beneficiary.
Beal charged officer's life insurance expense as follows:
2004 $2,000
2005 1,800
2006 1,500
2007 1,100
Total $6,400
=====

In Beal's December 31, 2007 Balance Sheet, the investment in cash surrender value should be:
A. $0
B. $1,600
C. $6,400
D. $8,000

B. $1,600
The $1,600 ending cash surrender value is the difference between the total premiums paid ($8,000 = 4 x $2,000) and the total amount charged to insurance expense ($6,400). An increasing portion of the premiums on life insurance are allocated to the investment feature of life insurance each year.

86

Alta Co. spent $400,000 during the current year developing a new idea for a product that was patented during the year. The legal cost of applying for a patent license was $40,000. Also, $50,000 was spent to successfully defend the rights of the patent against a competitor. The patent has a life of 20 years. Under U.S. GAAP, what amount should Alta capitalize related to the patent?
A. $ 40,000
B. $ 50,000
C. $ 90,000
D. $490,000

C. $ 90,000
The legal cost for applying for a patent can be capitalized. Alta can also capitalize the costs associated with the legal defense of the patent. This response correctly includes the legal costs associated with applying for and defending the patent.

87

Star Co. leases a building for its product showroom. The 10-year non-renewable lease will expire on December 31, 2007. In January 2002, Star redecorated its showroom and made leasehold improvements of $48,000. The estimated useful life of the improvements is 8 years. Star uses the straight-line method of amortization.
What amount of leasehold improvements, net of amortization, should Star report in its June 30, 2002, Balance Sheet?

A. $45,600
B. $45,000
C. $44,000
D. $43,200

C. $44,000
Six years remained in the lease term at the point the leasehold improvements were made. Thus, they should be amortized over six years, rather than over their eight-year useful life.
Leasehold improvements revert to the lessor at the end of the lease term. As of June 30, 2002, the leasehold improvements have been used only 1/2 year. Thus, the net balance in leasehold improvements is $44,000 [$48,000-($48,000/6)(1/2)].

88

On January 1, 2004, Bay Co. acquired a land lease for a 21-year period with no option to renew.
The lease required Bay to construct a building in lieu of rent. The building, completed on January 1, 2005, at a cost of $840,000, will be depreciated using the straight-line method. At the end of the lease, the building's estimated market value will be $420,000.

What is the building's carrying amount in Bay's December 31, 2005 Balance Sheet?

A. $798,000
B. $800,000
C. $819,000
D. $820,000

A. $798,000
The building is a leasehold improvement because it reverts to the lessor at the end of the lease. The residual value belongs to the lessor and is not relevant to the lessee. The building was completed at the beginning of the second year of the lease. Therefore, the total cost to the lessee of $840,000 is amortized over 20 years, not 21.
The carrying value of the leasehold improvement at the end of 2005, the first year of the building's life but the second year of the lease, is $798,000 = $840,000(19/20).

89

On January 2, 2005, Ames Corp. signed an eight-year lease for office space. Ames has the option to renew the lease for an additional four-year period on or before January 2, 2012. During January 2005, Ames incurred the following costs:

$120,000 for general improvements to the leased premises with an estimated useful life of 10 years.
$50,000 for office furniture and equipment with an estimated useful life of 10 years.
At December 31, 2005, Ames' intentions as to the exercise of the renewal option are uncertain. A full year's amortization of leasehold improvements is taken for calendar year two. In Ames' December 31, 2005 Balance Sheet, accumulated amortization should be:

A. $10,000
B. $15,000
C. $17,000
D. $21,250

B. $15,000
The appropriate amortization period for the leasehold improvements is eight years because renewal is uncertain. $120,000/8 = $15,000. This is the amount in accumulated amortization because the property has been leased only one year. The office furniture and equipment are not included in leasehold improvements because they belong to the lessee.

90

ABC Co. was organized on July 15, 2004, and earned no significant revenues until the first quarter of 2007. During the period 2004-2006, ABC acquired plant and equipment, raised capital, obtained financing, trained employees, and developed markets.
In its financial statements as of December 31, 2006, ABC should defer all costs incurred during 2004-06,

A. Net of revenues earned, which are recoverable in future periods.
B. Net of revenues earned.
C. Which are recoverable in future periods.
D. Without regard to net revenues earned or recoverability in future periods.

C. Which are recoverable in future periods.

91

Northstar Co. acquired a registered trademark for $600,000. The trademark has a remaining legal life of five years, but can be renewed every 10 years for a nominal fee. Northstar expects to renew the trademark indefinitely. What amount of amortization expense should Northstar record for the trademark in the current year?
A. $0
B. $15,000
C. $40,000
D. $120,000

A. $0
When the intangible asset can be renewed indefinitely, and the company has the positive ability and intent to continuously renew, then the intangible asset is an indefinite life intangible. Indefinite life intangibles are not amortized, but are tested for impairment on an annual basis.

92

Which of the following is not one of the qualitative factors considered to determine if it is more likely than not that the reporting unit is less than its carrying value?
A. Industry and market conditions, such as deterioration in the industry environment, increased competition, decline in market-dependent multiples, change in the market for the entity's products or services, or a regulatory or political development.
B. Cost factors, such as increases in raw materials, labor or other costs that have a negative effect on earnings and cash flows.
C. Decline in the implied goodwill by using a discounted cash flow model.
D. Overall financial performance, such as negative cash flows or actual or projected declines in revenues, earnings or cash flows

C. Decline in the implied goodwill by using a discounted cash flow model.
This is a quantitative measure of the implied goodwill. The question asked which of the responses is not a qualitative factors used in the pre-step for goodwill impairment. This response is incorrect also because implied goodwill is determined by comparing the fair market value of the reporting unit to the fair market value of the identifiable assets - not by using a discount model.

93

Goodwill should be tested for value impairment at which of the following levels?
A. Each identifiable long-term asset.
B. Each reporting unit
C. Each acquisition unit
D. The entire business as a whole

B. Each reporting unit

94

Large purchased all of Small's voting stock for $11 million when Small's total owners' equity was $4 million. The book value and market value of Small's liabilities equal $3 million. However, the market value of Small's total assets equals $9 million. What amount of goodwill is recorded by Large (in millions)?
A. $7
B. $2
C. $5
D. $6

C. $5
The market value of Small's net assets is $6 ($9 - $3). Goodwill ($5) is the difference between the purchase price of $11 and the market value of Small's net assets of $6. Goodwill is the portion of the purchase price not attributable to identifiable assets.

95

Firm A is negotiating with Firm B to purchase Firm B and bring it into the corporate organization headed by Firm A. The two firms agree to the following:
Firm B's average annual income is $900, to continue for 10 years after purchase.
Firm B's total owner's equity is $2,000.
Firm B's market value of net identifiable assets is $3,500.
The average rate of return in B's industry is 10%.
The risk adjusted rate of return for the purchase is 8%.
Compute the purchase price for B implied by this information. The present value of an annuity of $1 for 10 years at 8% is 6.71008, and at 10% is 6.14457.

A. $7,801
B. $8,197
C. $6,880
D. $7,191

D. $7,191
With the information provided, goodwill can be computed directly as the present value of excess earnings. Goodwill is then added to the market value of net identifiable assets to yield the purchase price. Excess earnings is the difference between B's earnings and the expected earnings in B's industry for a firm the size of B, based on market value of net assets. Given B's size, B is expected to earn $350 per year (.10 x $3,500). Excess earnings = $900 - $350 = $550. Goodwill = present value of excess earnings = $550(6.71008) = $3,691. The implied purchase price = $3,500 + $3,691 = $7,191.

96

Under IFRS, an entity that acquires an intangible asset may use the revaluation model for subsequent measurement only if:
A. The useful life of the intangible asset can be reliably determined.
B. An active market exists for the intangible asset.
C. The cost of the intangible asset can be measured reliably.
D. The intangible asset is a monetary asset.

B. An active market exists for the intangible asset.

97

After an impairment loss is recognized, the adjusted carrying amount of the intangible asset shall be its new accounting basis. Under IFRS, which of the following statements about subsequent reversal of a previously recognized impairment loss is correct?

A. It is prohibited.
B. It is allowed when events and circumstances change.
C. It is allowed only if the intangible asset is recorded at fair value.
D. The recovery amount can exceed the carrying value at the time of the initial impairment.

B. It is allowed when events and circumstances change.

98

Lyle, Inc. is preparing its financial statements for the year ended December 31, 2004. Accounts payable amounted to $360,000 before any necessary year-end adjustment related to the following:

At December 31, 2004, Lyle has a $50,000 debit balance in its accounts payable to Ross, a supplier, resulting from a $50,000 advance payment for goods to be manufactured to Lyle's specifications.
Checks in the amount of $100,000 were written to vendors and recorded on December 29, 2004. The checks were mailed on January 5, 2005.
What amount should Lyle report as accounts payable in its December 31, 2004 balance sheet?

A. $510,000
B. $410,000
C. $310,000
D. $210,000

A. $510,000
Balance before adjustments
$360,000
Plus the advance, which should be placed in an asset account: advances to supplier. The $50,000 is added to accounts payable because accounts payable was debited on payment of the advance.
50,000
Include the amounts for checks written but not mailed. This amount should be reinstated to cash.
100,000
Equals correct ending balance
$510,000

99

Rabb Co. records its purchases at gross amounts but wishes to change to recording purchases net of purchase discounts. Discounts available on purchases recorded from October 1, 2003 to September 30, 2004, totaled $2,000. Of this amount, $200 is still available in the accounts payable balance.
The balances in Rabb's accounts as of and for the year ended September 30, 2004, before conversion are:

Purchases
$100,000
Purchase discounts taken
800
Accounts payable
30,000
What is Rabb's accounts payable balance as of September 30, 2004 after the conversion?
A. $29,800
B. $29,200
C. $28,800
D. $28,200

A. $29,800
Only the discounts still available on accounts yet to be paid can be deducted from the accounts payable balance, which now stands at gross.
The firm owes $30,000 at gross, which means that if none of the cash discounts available are taken, the firm will pay $30,000. The net counterpart of that amount is $29,800 ($30,000 - $200). If the firm pays all its remaining accounts within the cash discount period, it would pay only $29,800.

That is the assumption underlying the net method.

100

Which of the following is generally associated with payables classified as accounts payable?
Periodic payment of interest Secured by collateral
No No
No Yes
Yes No
Yes Yes

Periodic payment of interest Secured by collateral
No No

101

On December 31, 2005, special insurance costs, incurred but unpaid, were not recorded.
If these insurance costs were related to work-in-process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31, 2005 balance sheet?
Accrued liabilities Retained earnings
No effect No effect
No effect Overstated
Understated No effect
Understated Overstated

Accrued liabilities Retained earnings
Understated No effect
Accrued liabilities are understated because the insurance costs were incurred but not paid. The firm has an obligation for coverage received. The omitted journal entry is:
Accrued liabilities are understated because the insurance costs were incurred but not paid. The firm has an obligation for coverage received. The omitted journal entry is:
Work in process
Accrued payables
Retained earnings is unaffected because no expense has been incurred. The omission of the above entry has no effect on expenses or retained earnings.
Work in process is an asset. When work in process is completed and sold, this part of the total cost of work in process will be expensed.

102

Gar, Inc.'s trial balance reflected the following liability account balances at December 31, 2005:

Accounts payable $19,000
Bonds payable, due 2006 34,000
Deferred income tax payable 4,000
Discount on bonds payable 2,000
Dividends payable on 2/15/06 5,000
Income tax payable 9,000
Notes payable, due 1/19/07 6,000
The deferred income tax payable is based on temporary differences that will reverse in 2007 and 2008.

In Gar's December 31, 2005 balance sheet, the current liabilities total was

A. $71,000
B. $69,000
C. $67,000
D. $65,000

D. $65,000
Accounts payable $19,000
Bonds payable, due 2006 34,000
Discount on bonds payable (2,000)
Dividends payable on 2/15/06 5,000
Income tax payable 9,000
Current liabilities at 12/31/05 $65,000
The deferred tax liability could not be current because deferred tax liabilities are classified based on the underlying item, giving rise to the future temporary difference. The reversal of the temporary difference does not begin until 2007, which is more than one year after the balance sheet date.

Therefore, the underlying accounts that give rise to the deferred tax liability must be noncurrent, which causes the deferred tax liability to be also noncurrent.

103

Black Corp.'s accounts payable at December 31, 2004, totaled $900,000 before any necessary year-end adjustments relating to the following transactions:

On December 27, 2004, Black wrote and recorded checks to creditors totaling $400,000, causing an overdraft of $100,000 in Black's bank account at December 31, 2004. The checks were mailed out on January 10, 2005.
On December 28, 2004, Black purchased and received goods for $153,061, terms 2/10, n/30. Black records purchases and accounts payable at net amounts. The invoice was recorded and paid on January 3, 2005.
Goods shipped F.O.B. destination on December 20, 2004 from a vendor to Black were received January 2, 2005. The invoice cost was $65,000.
At December 31, 2004, what amount should Black report as total accounts payable?

A. $1,515,000
B. $1,450,000
C. $1,153,061
D. $1,053,061

B. $1,450,000
Preadjusted balance in accounts payable
$900,000
Plus checks not sent to creditors until Jan. 10 (this amount was debited to accounts payable and must be reversed because the checks have not been sent - accounts payable has not been reduced as of December 31)
400,000
Plus goods received Dec. 28, at net: .98($153,061)(the firm records purchases at net of 2% discount)
150,000
Equals ending accounts payable
$1,450,000
There is no liability at December 31, 2004 for the goods shipped FOB destination because title does not pass until the goods reach the destination, which did not occur until January.
The firm must include the Dec. 28 receipt of goods in accounts payable because the firm has received the goods.

104

Acme Co.'s accounts payable balance at December 31 was $850,000 before necessary year-end adjustments, if any, related to the following information:
At December 31, Acme has a $50,000 debit balance in its accounts payable resulting from a payment to a supplier for goods to be manufactured to Acme's specifications.

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

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

A. $850,000
B. $895,000
C. $900,000
D. $945,000

A. $850,000
The $50,000 is not part of accounts payable, but it is a prepayment. It should be removed from accounts payable.

105

After three profitable years, Dodd Co. decided to offer a bonus to its branch manager, Cone, of 25% of income over $100,000 earned by his branch. For the year 2002, income for Cone's branch was $160,000 before income taxes and Cone's bonus. Cone's bonus is computed on income in excess of $100,000 after deducting the bonus, but before deducting taxes. What is Cone's bonus for the year 2002?
A. $12,000
B. $15,000
C. $25,000
D. $32,000

A. $12,000
The following equation expresses the relationship. Let B = bonus.
B = .25($160,000 - $100,000 - B)

B = .25($60,000 - B)

B = $15,000 - .25B

1.25B = $15,000

B = $15,000/1.25 = $12,000

106

Under state law, Acme may pay 3% of eligible gross wages or it may reimburse the state directly for actual unemployment claims.
Acme believes that actual unemployment claims will be 2% of eligible gross wages and has chosen to reimburse the state. Eligible gross wages are defined as the first $10,000 of gross wages paid to each employee. Acme had five employees each of whom earned $20,000 during 2004.

In its December 31, 2004 balance sheet, what amount should Acme report as accrued liability for unemployment claims?

A. $1,000
B. $1,500
C. $2,000
D. $3,000

A. $1,000
The wage limit on unemployment tax is $10,000. Thus, the total accrued liability, which is also the unemployment tax amount, is 5($10,000)(.02) = $1,000.

107

Dana Co.'s officers' compensation expense account had a balance of $224,000 at December 31, 2004 before any appropriate year-end adjustment relating to the following:
No salary accrual was made for December 30-31, 2004. Salaries for the two-day period totaled $3,500.

2004 officers' bonuses of $62,500 were paid on January 31, 2005.

In its 2004 income statement, what amount should Dana report as officers' compensation expense?

A. $290,000
B. $286,500
C. $227,500
D. $224,000

A. $290,000
Both adjustments are included in compensation expense because they are costs of services rendered by employees in 2004. The firm has incurred a liability and therefore an expense as of 12/31/92 for each of these items. $290,000 = $224,000 + $3,500 + $62,500.

108

Rice Co. salaried employees are paid biweekly. Advances made to employees are paid back by payroll deductions. Information relating to salaries follows:
12/31/05 12/31/06
Employee advances $24,000 $ 36,000
Accrued salaries payable 40,000 ?
Salaries expense during the year 420,000
Salaries paid during the year (gross) 390,000

In Rice's December 31, 2006 balance sheet, accrued salaries payable was
A. $94,000
B. $82,000
C. $70,000
D. $30,000

C. $70,000

An equation shows the changes in the accrued salaries payable account and leads to the ending 12/31/06 balance in accrued salaries payable:
Beginning balance + salaries expense - salaries paid = Ending balance
$40,000 + $420,000 - $390,000 = $70,000

109

Lime Co.'s payroll for the month ended January 31, 2005, is summarized as follows:
Total wages $10,000
Federal income tax withheld 1,200
All wages paid were subject to FICA. FICA tax rates were 7% each for employee and employer. Lime remits payroll taxes on the 15th of the following month. In its financial statements for the month ended January 31, 2005, what amounts should Lime report as total payroll tax liability and as payroll tax expense?

Liability Expense
$1,200 $1,400
$1,900 $1,400
$1,900 $700
$2,600 $700

$2,600 $700
The liability is the sum of the income tax withheld ($1,200) and twice the FICA rate applied to wages ($10,000 x .14 = $1,400) for a total of $2,600. The firm must pay 7% as well as the employees. The firm withholds the employee's 7% FICA tax thus increasing the firm's liability for FICA until these amounts are remitted, which occurs the next month.
The only firm expense is the firm's share of FICA tax: .07 x $10,000 or $700. The employee income tax and FICA withholdings are not expenses of the firm but rather of the employees.

110

Bloy Corp.'s payroll for the pay period ended October 31, 2005 is summarized as follows:
Federal income Amount of wages subject to payroll taxes
Department Payroll Total Wages Tax withheld F.I.C.A. Unemployment
Factory 22,000 3,000 16,000 2,000
Sales 18,000 2,000 8,000 -
Office 60,000 7,000 56,000 18,000
Total $100,000 $12,000 $80,000 $20,000
========= ========= ======== =========
Assume the following payroll tax rates:

F.I.C.A. for employer and employee 7% each

Unemployment 3%

What amount should Bloy accrue as its share of payroll taxes in its October 31, 2005 balance sheet?

A. $18,200
B. $12,600
C. $11,800
D. $6,200

D. $6,200
This question asks for the ending payroll tax liability. This amount is the employer's share of FICA at 7% and the unemployment tax at 3%. Both have maximum wage limits. The $6,200 ending payroll tax liability is computed as $80,000(.07) + $20,000(.03).

111

Buc Co. receives deposits from its customers to protect itself against nonpayments for future services. These deposits should be classified by Buc as
A. A liability.
B. Revenue.
C. A deferred credit deducted from accounts receivable
D. A contra account

A. A liability.

112

On March 31, 2005, Dallas Co. received an advance payment of 60% of the sales price for special order goods to be manufactured and delivered within five months.
At the same time, Dallas subcontracted for production of the special order goods at a price equal to 40% of the main contract price.
What liabilities should be reported in Dallas' March 31, 2005 balance sheet?

Deferred revenues Payables to subcontractor
None None
60% of main contract price 40% of main contract price
60% of main contract price None
None 40% of main contract price

Deferred revenues Payables to subcontractor
60% of main contract price None

The only liability (deferred revenue) to be recorded is the advance for 60% of the main contract price.
Dallas received this cash and has a liability for that amount until it performs on the contract. Dallas has no liability for the subcontracted production because no resources have been exchanged.

113

Bart Co. requires nonrefundable advance payments with special orders for machinery constructed to customer specifications.
Information for 2004 is as follows:
Customer advances - balance 12/31/03 $590,000
Advances received with orders in 2004 920,000
Advances applied to orders shipped in 2004 820,000
Advances applicable to orders cancelled in 2004 250,000
In Bart's December 31, 2004 balance sheet, what amount should be reported as a current liability for customer deposits?

A. $740,000
B. $690,000
C. $440,000
D. $0

C. $440,000
The customer advances account is a liability. It represents amounts received from customers for orders not yet filled by the firm. Advances on cancelled orders may or may not be returned, but either way cancellation reduces the liability.

An analysis of the liability:

Beg. Balance + advances received - advances applied - advances cancelled = End. Balance
$590,000 + $920,000 - $820,000 - $250,000 = $440,000
When an order is filled, the advance is applied to the total purchase price. An advance is an amount already paid by the customer toward the total purchase price.

114

Fell, Inc. operates a retail grocery store that is required by law to collect refundable deposits of $.05 on soda cans.
Information for 2004 follows:

Liability for returnable deposits - 12/31/03 $ 150,000
Cans of soda sold in 2004 10,000,000
Soda cans returned in 2004 11,000,000
On February 1, 2004, Fell subleased space and received a $25,000 deposit to be applied toward rent at the expiration of the lease in 2008. In Fell's December 31, 2004 balance sheet, the current and noncurrent liabilities for deposits were

Current Noncurrent
$125,000 $0
$100,000 $25,000
$100,000 $0
$25,000 $100,000

Current Noncurrent $100,000 $25,000
The $25,000 rent deposit is a noncurrent liability because it will be applied toward the rental of a tenant more than one year after the 2004 balance sheet.

The ending liability for cans = $150,000 - (11,000,000 - 10,000,000).05 = $100,000.

When customers return cans, they are paid $.05 for each. Can returns reduce the liability. At sale, the deposit is collected and the liability increases. More cans were returned than were sold. Therefore, the deposit liability for cans decreased during the year. This is a current liability. Most customers do not keep cans for more than one year before returning them.

115

Ryan Co. sells major household appliance service contracts for cash. The service contracts are for a one-year, two-year, or three-year period. Cash receipts from contracts are credited to unearned service contract revenues. This account had a balance of $720,000 at December 31, 2005 before year-end adjustment. Service contract costs are charged as incurred to the service contract expense account, which had a balance of $180,000 at December 31, 2005. Outstanding service contracts at December 31, 2005 expire as follows:
During 2006 $150,000
During 2007 225,000
During 2008 100,000
What amount should be reported as unearned service contract revenues in Ryan's December 31, 2005 balance sheet?

A. $540,000
B. $475,000
C. $295,000
D. $245,000

B. $475,000

The total unearned revenue is the sum of contract expirations:
Expirations:
During 2006 $150,000
During 2007 225,000
During 2008 100,000
Total liability $475,000

116

Marr Co. sells its products in reusable containers. The customer is charged a deposit for each container delivered and receives a refund for each container returned within two years after the year of delivery.
Marr accounts for the containers not returned within the time limit as being retired by sale at the deposit amount. Information for 2005 is as follows:
Container deposits at December 31, 2004 from deliveries in:
2003 $150,000
2004 430,000 $580,000

Deposits for containers delivered in 2005 780,000
Deposits for containers returned in 2005 from deliveries in:
2003 $ 90,000
2004 250,000
2005 286,000 626,000

In Marr's December 31, 2005 balance sheet, the liability for deposits on returnable containers should be
A. $494,000
B. $584,000
C. $674,000
D. $734,000

C. $674,000
At the end of 2005, any remaining 2003 deposits not claimed by returning containers are recognized as revenue and therefore no longer included in the ending 2005 container deposit liability. Customers are given only two years to return containers. The ending 2005 liability is:
Deposits - Returns = Container deposit liability
From 2004 $430,000 - $250,000 = $180,000
From 2005 780,000 - 286,000 = 494,000
Total 2005 container deposit liab. $674,000

117

A company has outstanding accounts payable of $30,000 and a short-term construction loan in the amount of $100,000 at year end. The loan was refinanced through issuance of long-term bonds after year end but before issuance of financial statements. How should these liabilities be recorded in the balance sheet?

A. Long-term liabilities of $130,000.
B. Current liabilities of $130,000
C. Current liabilities of $30,000, long-term liabilities of $100,000
D. Current liabilities of $130,000, with required footnote disclosure of the refinancing of the loan

C. Current liabilities of $30,000, long-term liabilities of $100,000
The accounts payable is a current liability. The refinancing resulted in reclassifying the construction loan (which would otherwise also be current) as a noncurrent liability. The replacement of the loan with a noncurrent liability (bonds) took place before the financial statements were issued, thus meeting the requirements for refinancing on a long-term basis.

118

Gains or losses from the early extinguishment of debt, if material, should be
A. Recognized in income from continuing operations in the period of extinguishment.
B. Recognized as other comprehensive income in the period of extinguishment.
C. Amortized over the life of the new issue
D. Amortized over the remaining original life of the extinguished issue

A. Recognized in income from continuing operations in the period of extinguishment.

119

The following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by Knob Co. to Mene Corp. in full liquidation of Knob's liability to Mene:

Carrying amount of liability liquidated $150,000
Carrying amount of real estate transferred 100,000
Fair value of real estate transferred 90,000
What amount should Knob report as a gain (loss) on restructuring of payables?

A. ($10,000)
B. $0
C. $50,000
D. $60,000

D. $60,000

The gain on debt restructure recognized by the debtor Knob is the difference between the book value of the debt ($150,000) and the market value of the asset transferred in settlement ($90,000). Thus, the gain equals $60,000.

120

On December 31, 2005. Cobb issued 2,000 of its 10%, $1,000 bonds at 99. The issuance price established a bond discount of $20,000. In connection with the sale of these bonds. Cobb paid the following expenses:

Legal and accounting fees $45,000
Printing of the prospectus 55,000
Underwriting fees 85,000
In Cobb's December 31, 2005 balance sheet, bond issue costs should be reported as

A. $120,000
B. $130,000
C. $160,000
D. $185,000

D. $185,000
Legal and accounting fees
$ 45,000
Printing of the prospectus
55,000
Underwriting fees
85,000
Total bond issue costs
$185,000
Bond issue costs are those costs incurred to facilitate the issuance of the bonds. All of the above costs contribute to that effort.

121

Foley Co. is preparing the electronic spreadsheet below to amortize the discount on its 10-year, 6%, $100,000 bonds payable. Bonds were issued on December 31 to yield 8%. Interest is paid annually. Foley uses the effective interest method to amortize bond discounts.
A B C D E
1 Year Cash paid Interest expense Discount amortization Carrying amount
2 1 $86,580
3 2 $6,000

Which formula should Foley use in cell E3 to calculate the carrying amount of the bonds at the end of Year 2?
A. E2+D3
B. E2-D3
C. E2+C3
D. E2-C3

A. E2+D3
This question is a basic discount amortization scenario. The carrying amount of the bond will increase by the amount of the discount amortization each period until the carrying amount is $100,000 at maturity. Adding cells E2+D3 together will add the discount amortized for the period to the carrying amount of the bond, giving the new carrying amount at the end of the period.

122

On January 2, 2003, Chard Co. issued 10-year convertible bonds at 105. During 2006, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds. At conversion, the market price of Chard's common stock was 50 percent above its par value.
Depending on whether the book value method or the market value method was used, Chard would recognize gains or losses on conversion when using the

Book value method Market value method
Either gain or loss Gain
Either gain or loss Loss
Neither gain nor loss Loss
Neither gain nor loss Gain

Neither gain nor loss Loss

Under the book value method, the book value of the bonds converted is transferred to the common stock account and additional paid-in capital. No gain or loss is recorded. The market value of the stock issued on conversion is not used in the recording of the stock.

The stock's market value is much higher than its par value. Thus, the bond carrying value is considerably less than the market value of the stock issued according to the information in the question.

123

On January 2, 2002, Chard Co. issued 10-year convertible bonds at 105. During 2005, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds.
At conversion, the market price of Chard's common stock was 50 percent above its par value.
On January 2, 2002, cash proceeds from the issuance of the convertible bonds should be reported as

A. Contributed capital for the entire proceeds.
B. Contributed capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance.
C. A liability for the face amount of the bonds and contributed capital for the premium over the face amount
D. A liability for the entire proceeds

D. A liability for the entire proceeds

124

Choose the correct statement concerning the classification of a liability when a firm is subject to a debt covenant.
A. All liabilities callable on demand are classified as current in all circumstances.
B. If the liability is callable on demand, the covenant is violated, and the covenant is violated, then the liability is classified as current if the violation is waived by the creditor.
C. If the covenant includes a subjective acceleration clause and there is only a remote chance that debt will be called, then the liability is classified as noncurrent.
D. If a covenant grants a grace period during which it is possible that the violation will be cured, then the liability is classified as noncurrent.

C. If the covenant includes a subjective acceleration clause and there is only a remote chance that debt will be called, then the liability is classified as noncurrent.

It must be at least possible that the liability will be called in order for the classification to downgraded to current.

125

A firm's debt to equity ratio (total debt to total owners' equity) cannot exceed 3.0 without allowing a major creditor to call a loan to the firm. The ratio is currently at the maximum before any of the transactions are listed. Which of the following transactions would not subject the firm to an immediate call by the creditor?
A. Recognize an increase in the current deferred income tax liability.
B. Purchase treasury stock for less than its original issue price.
C. Purchase treasury stock for more than its original issue price.
D. Retire a different loan by issuing common stock.

D. Retire a different loan by issuing common stock.

Any treasury stock purchase reduces total OE by the amount paid. There is no effect on debt. The denominator of the debt to equity is reduced, causing the ratio to increase.

126

Main Co. issued bonds with detachable common stock warrants.
Only the warrants had a known market value. The sum of the fair value of the warrants and the face amount of the bonds exceeds the cash proceeds.
This excess is reported as

A. Discount on bonds payable.
B. Premium on bonds payable
C. Common stock subscribed.
D. Contributed capital in excess of par-stock warrants

A. Discount on bonds payable.

127

On October 1, 2005, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note's market rate of interest was 11%.
Fleur recorded the purchase at the note's face amount. All of the merchandise was sold by December 1, 2005. Fleur's 2005 financial statements reported interest payable and interest expense on the note for three months at 16%. All amounts due on the note were paid February 1, 2006.

Fleur's 2005 cost of goods sold for the holiday merchandise was

A. Overstated by the difference between the note's face amount and the note's October 1, 2005 present value.
B. This is overstated by the difference between the note's face amount and the note's present value at October 1, 2005 plus 11% interest for two months.
C. Understated by the difference between the note's face amount and the note's October 1, 2005 present value.
D. Understated by the difference between the note's face amount and the note's October 1, 2005 present value plus 16% interest for two months.

C. Understated by the difference between the note's face amount and the note's October 1, 2005 present value.

The note (and merchandise) should have been recorded at its present value using the market interest rate of 11%. This rate is lower than the stated rate of 16% implying that the present value of the note (face value and interest payments at 16%) using 11% exceeds the face value of the note.
Thus, the merchandise was recorded at an amount which understated its market value. All the merchandise was sold before the end of the year causing cost of goods sold to be similarly understated.

128

On September 30, World Co. borrowed $1,000,000 on a 9% note payable. World paid the first of four quarterly payments of $264,200 when due on December 30. In its December 31, balance sheet, what amount should World report as note payable?
A. $735,800
B. $750,000
C. $758,300
D. $825,800

C. $758,300
The first payment included interest of $22,500 (.09 x .25 x $1,000,000). Note that interest rates are always expressed for an annual period. Only 25% of year elapsed from Sept. 30 to the end of the year. The rest of the payment ($241,700 = $264,200 - $22,500) is principal. The note payable balance at Dec. 31 therefore is $758,300 ($1,000,000 - $241,700).

129

Quoit, Inc. issued preferred stock with detachable common stock warrants. The issue price exceeded the sum of the warrants' fair value and the preferred stocks' par value. The preferred stocks' fair value was not determinable.
What amount should be assigned to the warrants outstanding?

A. Total proceeds.
B. Excess of proceeds over the par value of the preferred stock
C. The proportion of the proceeds that the warrants' fair value bears to the preferred stocks' par value
D. The fair value of the warrants

D. The fair value of the warrants

The warrants should be recorded at their total market value. The remaining proceeds should be allocated to the preferred.

130

In a modification of the terms, troubled debt restructure of type II (sum of new flows > book value of debt), what amount of gain is recognized by the debtor?
A. The difference between the book value of the debt and the sum of new cash flows.
B. The difference between the present value of the new flows using the original rate of interest and the book value of the debt.
C. No gain is recognized.
D. The difference between the present value of the new flows using the new rate of interest (based on the restructured flows) and the book value of the debt

C. No gain is recognized.

Although the debtor has an economic gain (the creditor is making a concession), GAAP requires that the debtor compute the new rate of interest based on the restructured cash flows and recognize interest expense over the note term. No gain is recognized by the debtor.

131

Blue Corp.'s December 31, 1991 balance sheet contained the following items in the long-term liabilities section:
9.75% registered debentures, callable in 2002, due in 2007 $700,000
9.5% collateral trust bonds, convertible into common stock beginning in 2000, due in 2010 600,000
10% subordinated debentures ($30,000 maturing annually beginning in 1997) 300,000
What is the total amount of Blue's term bonds?
A. $600,000
B. $700,000
C. $1,000,000
D. $1,300,000

D. $1,300,000
Both the registered debentures and collateral trust bonds are term bonds. A term bond matures on a single date. Although the bonds may be called or converted, these events may not occur, in which case they would be retired all on one date.
The subordinated debentures are serial bonds that mature in $30,000 amounts beginning 1997. They do not all mature on the same date.

132

On September 1, 2003, Brak Co. borrowed on a $1,350,000 note payable from the Federal Bank.
The note bears interest at 12% and is payable in three equal annual principal payments of $450,000. On this date, the bank's prime rate was 11%. The first annual payment for interest and principal was made on September 1, 2004.

At December 31, 2004, what amount should Brak report as accrued interest payable?

A. $54,000
B. $49,500
C. $36,000
D. $33,000

C. $36,000
Although the question is not completely clear, interest is paid at the time each principal payment is made. Thus, on 9/1/04, after the principal payment of $450,000 (and interest as well) is made, the remaining note balance is $900,000 ($1,350,000 - $450,000). Note that only the principal payment reduces the note balance. Interest for four months to 12/31/04 is recorded in accrued interest payable: $36,000 ($900,000 x .12 x 1/3 year).

133

On October 1, 2004, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise.
At that date, there was no direct method of pricing the merchandise, and the note's market rate of interest was 11%. Fleur recorded the purchase at the note's face amount. All of the merchandise was sold by December 1, 2004.
Fleur's 2004 financial statements reported interest payable and interest expense on the note for three months at 16%. All amounts due on the note were paid February 1, 2005.

As a result of Fleur's accounting treatment of the note, interest, and merchandise, which of the following items was reported correctly?

12/31/04 retained earnings 12/31/04 interest payable
Yes Yes
No No
Yes No
No Yes

No Yes
Interest expense on notes should reflect the market interest rate at the date of issuing the note. This firm is recording interest expense at the 16% stated rate rather than the 11% market rate. Thus, interest expense is incorrectly recorded.
Also, the merchandise and note should have been recorded at the present value of the note using the market interest rate. Thus, cost of goods sold is incorrectly measured. The result of these two effects is that income and retained earnings are misstated.

134

Loeb's Corp. frequently borrows from the bank in order to maintain sufficient operating cash. The following loans were at a 12% interest rate, with interest payable at maturity. Loeb repaid each loan on its scheduled maturity date.

Date of loan Amount Maturity date Term of loan
11/1/04 $ 5,000 10/31/05 1 Year
2/1/05 15,000 7/31/05 6 Months
5/1/05 8,000 1/31/06 9 Months
Loeb records interest expense when the loans are repaid. As a result, the interest expense of $1,500 was recorded in 2005. If no correction is made, by what amount would 2005 interest expense be understated?

A. $540
B. $620
C. $640
D. $720

A. $540
First loan:

Interest expense included in the $1,500 = $5,000(.12) = $600
Interest expense that should have been included in 2005 interest expense = $5,000(.12)(10/12) = 500
Overstatement of 2005 interest expense = $100

Second loan: (no error because the term is completely within 2005 so the interest recognized equals the interest paid)


Third loan:
Interest expense included in the $1,500 = $0
(the loan and therefore the interest was not paid in 2005) = 0
Interest expense that should have been included in 2005 interest expense = $8,000(.12)(8/12) = 640
Understatement of 2005 interest expense = $640

Net understatement = $540

135

A company issued a short-term note payable to a bank with a stated 12 percent rate of interest . The bank charged a .5% loan origination fee and remitted the balance to the company.
The effective interest rate paid by the company in this transaction would be

A. Equal to 12.5%.
B. More than 12.5%
C. Less than 12.5%.
D. Independent of 12.5%

B. More than 12.5%
The .5% loan origination fee reduces the proceeds to the borrower AND increases the total interest to be paid by the same amount. The effect is to raise the interest rate above 12.5%.
Assume the loan amount is $1,000 before the loan origination fee. Therefore, the net amount loaned is $995 [1 - .005($1,000)]. However, the full $1,000 must be paid at maturity. The total interest to be paid is thus increased by the $5 origination fee ($1,000 - $995).

For simplicity, assume the loan is for a full year. Then total interest paid is: .12($1,000) + $5 = $125.

The effective rate of interest for the year then is: $125/$995 = .1256. This exceeds 12.5%.

136

Seco Corp. was forced into bankruptcy and is in the process of liquidating assets and paying claims. Unsecured claims will be paid at the rate of forty cents on the dollar.
Hale holds a $30,000 noninterest-bearing note receivable from Seco collateralized by an asset with a book value of $35,000, and a liquidation value of $5,000.
The amount to be realized by Hale on this note is

A. $5,000
B. $12,000
C. $15,000
D. $17,000

C. $15,000

This amount is only the liquidation value. Hale will also receive 40% of the remaining claim of ($30,000 - $5,000) is unsecured and at the 40% rate yields an additional claim of $10,000, for a total amount to be realized of $15,000.

137

Loeb's Corp. frequently borrows from the bank in order to maintain sufficient operating cash. The following loans were at a 12% interest rate, with interest payable at maturity. Loeb repaid each loan on its scheduled maturity date.

Date of loan Amount Maturity date Term of loan
11/1/04 $ 5,000 10/31/05 1 Year
2/1/05 15,000 7/31/05 6 Months
5/1/05 8,000 1/31/06 9 Months
Loeb records interest expense when the loans are repaid. As a result, the interest expense of $1,500 was recorded in 2005. If no correction is made, by what amount would 2005 interest expense be understated?

A. $540
B. $620
C. $640
D. $720

A. $540
First loan:

Interest expense included in the $1,500 = $5,000(.12) = $600
Interest expense that should have been included in 2005 interest expense = $5,000(.12)(10/12) = 500
Overstatement of 2005 interest expense = $100

Second loan: (no error because the term is completely within 2005 so the interest recognized equals the interest paid)


Third loan:
Interest expense included in the $1,500 = $0
(the loan and therefore the interest was not paid in 2005) = 0
Interest expense that should have been included in 2005 interest expense = $8,000(.12)(8/12) = 640
Understatement of 2005 interest expense = $640

Net understatement = $540

138

Which of the following is reported as interest expense?
A. Pension cost interest.
B. Postretirement healthcare benefits interest
C. Imputed interest on noninterest-bearing note
D. Interest incurred to finance construction of machinery for own use

C. Imputed interest on noninterest-bearing note

139

A firm is required by its creditors to maintain a 2.00 (or greater) current ratio in order to maintain compliance with a debt covenant. The current ratio of the firm is currently at the minimum before any of the transactions are listed. Which of the following actions would cause the firm to fall out of compliance?
A. Sell a used plant asset at book value.
B. Pay an account payable.
C. Declare cash dividends.
D. Pay cash dividends previously declared.

C. Declare cash dividends.
This transaction increases current liabilities, thus reducing the current ratio. The current ratio is current assets divided by current liabilities. There is no effect on current assets.

140

Which of the following actions helps a firm to maintain compliance with a debt covenant that includes a minimum current ratio and a minimum retained earnings balance: (1) refinancing current debt on a long-term basis, (2) appropriating retained earnings, (3) purchasing treasury stock, (4) declaring cash dividends.
A. 1 and 3
B. 2 and 4
C. 1 and 2
D. 1, 2 and 3

C. 1 and 2

Both actions are appropriate. Refinancing current debt on a long-term basis reduces current liabilities (increases noncurrent debt) and increases the current ratio. Appropriating retained earnings is an action that typically signals a future reduction in dividends, albeit on a temporary basis. As a result, total retained earnings is maintained at a higher level.

141

Which of the following accounting strategies (for financial reporting purposes) is the least likely for a firm that is currently only marginally fulfilling the quantitative measures (all involving earnings) of its debt covenants?
A. Using straight-line depreciation.
B. Changing to FIFO
C. Using the weighted average method for capitalizing interest during times of reduced interest rates, rather than the specific method.
D. Changing to the successful efforts method of accounting for natural resource exploration costs.

D. Changing to the successful efforts method of accounting for natural resource exploration costs.
This accounting change would cause earnings to be reduced, possibly significantly. The successful efforts method expenses the cost of all unsuccessful exploration efforts immediately.

142

Which of the following is generally associated with the terms of convertible debt securities?
A. An interest rate that is lower than nonconvertible debt.
B. An initial conversion price that is less than the market value of the common stock at time of issuance.
C. A non-callable feature
D. A feature to subordinate the security to nonconvertible debt

A. An interest rate that is lower than nonconvertible debt.

143

On June 30, 2004, Hamm Corp. had the face amount of $2,000,000 outstanding in 8% convertible bonds maturing on June 30, 2009. Interest is payable on June 30 and December 31.
Each $1,000 bond is convertible into 40 shares of Hamm's $20 par common stock. After amortization through June 30, 2004, the unamortized balance in the premium on bonds payable account was $50,000.

On June 30, 2004, all the bonds were converted when Hamm's common stock had a market price of $30 per share.

Under the book value method, what amount should Hamm credit to additional paid-in capital in recording the conversion?

A. $350,000
B. $400,000
C. $450,000
D. $800,000

C. $450,000
The journal entry under the book value method, which simply transfers the book value of the convertible bonds to owners' equity accounts (and does not use the market value of the stock to measure the new owners' equity accounts), is as follows:

Convertible bonds payable 2,000,000
+ Premium on convertible bonds payable 50,000
- Common stock (2,000 bonds)($20 par)(40 shares/bond) 1,600,000
= Additional paid in capital, common stock 450,000

144

Bondholders of Balm Co. converted their bonds into 90,000 shares of $5 par value common stock. In Balm's accounting records, the bonds had a par value of $775,000 and unamortized discount of $23,000 at the time of conversion. What amount of additional paid-in capital from the conversion should Balm record?
A. $302,000
B. $325,000
C. $348,000
D. $798,000

A. $302,000
Without fair value information, the book value method of allocating the bond carrying value to the owners' equity accounts must be used. The carrying value of the bond issue is $752,000 ($775,000 - $23,000). Of that amount, $450,000 is first allocated to the common stock account at par value (90,000 shares issued x $5). The remainder, or $302,000 ($752,000 - $450,000) is allocated to additional paid in capital.

145

Which of the following statements characterizes convertible debt?

A. The holder of the debt must be repaid with shares of the issuer's stock.
B. No value is assigned to the conversion feature when convertible debt is issued.
C. The transaction should be recorded as the issuance of stock.
D. The issuer's stock price is less than market value when the debt is converted.

B. No value is assigned to the conversion feature when convertible debt is issued.

That's why the full amount of convertible debt is assigned as a liability.

146

On March 1, 2005, Clark Co. issued bonds at a discount. Clark incorrectly used the straight-line method instead of the effective interest method to amortize the discount. How were the following amounts, as of December 31, 2005, affected by the error?
Bond carrying amount Retained earnings
Overstated Overstated
Understated Understated
Overstated Understated
Understated Overstated

Bond carrying amount Retained earnings
Overstated Understated

147

On January 1 of the current year, Lean Co. made an investment of $10,000. The following is the present value of $1.00 discounted at a 10% interest rate:
Present value of $1.00
Periods Discounted at 10%
1 .909
2 .826
3 .751
What amount of cash will Lean accumulate in two years?

A. $12,000
B. $12,107
C. $16,250
D. $27,002

B. $12,107
The future value of $1 is the reciprocal of the present value of $1. The $10,000 invested therefore will accumulate to $10,000(1/.826) = $12,107 in two years.
Another calculation leading to the same result is $10,000(1.10)(1.10) = $12,100 (discrepancy due to rounding of the present value factor).

148

Hancock Co.'s December 31, 2005 balance sheet contained the following items in the long-term liabilities section:

Unsecured
9.375% registered bonds ($25,000 maturing annually beginning in 2009) $ 275,000
11.5% convertible bonds, callable beginning in 2014, due 2025 125,000
Secured
9.875% guaranty security bonds, due 2025 $ 250,000
10.0% commodity backed bonds ($50,000 maturing annually beginning in 2010) 200,000
What are the total amounts of serial bonds and debenture bonds?

Serial bonds Debenture bonds
$475,000 $400,000
$475,000 $125,000
$450,000 $400,000
$200,000 $650,000

Serial bonds Debenture bonds
$475,000 $400,000
Serial bonds mature at regular intervals rather than on one single date. Debenture bonds are not secured but rather are backed only by the general credit of the issuing firm. Debenture bonds can be serial bonds. Therefore, the total amount of debenture bonds equals the total of the unsecured bond issues or $400,000 ($275,000 + $125,000).

There are two serial bonds: the 9.375% unsecured bonds ($275,000) and the 10% secured bonds ($200,000), for a total of $475,000.

Debenture (unsecured) bonds can mature serially.

149

On October 1, 2005, Brock, Inc. issued 200 of its 10%, $1,000 bonds at 101 plus accrued interest. The bonds are dated July 1, 2005, and mature on July 1, 2015. Interest is payable semiannually on January 1 and July 1.
At the time of issuance, Brock received cash of

A. $207,000
B. $205,000
C. $202,000
D. $197,000

A. $207,000
The proceeds on a bond issue equal the total bond price plus accrued interest since the last interest date. The proceeds of $207,000 = 200($1,000)(1.01) + 200($1,000)(.10)(3/12).
The 3/12 factor is the time between the bond date (or previous interest date) and the issuance date.

150

A bond issued on June 1, 2004 has interest payment dates of April 1 and October 1. The bond interest expense for the year ended December 31, 2004 is for a period of
A. Three months.
B. Four months
C. Six months
D. Seven months

D. Seven months

151

On June 30, 2005, Huff Corp. issued at 99, 1000 of its 8%, $1,000 bonds. The bonds were issued through an underwriter to whom Huff paid bond issue costs of $35,000.
On June 30, 2005, Huff should report the bond liability at

A. $955,000
B. $990,000
C. $1,000,000
D. $1,025,000

A. $955,000
The net carrying value equals total face value less the discount less the bond issue costs. The discount is implied in the "99" price which is stated as a percent of face value: $955,000 = (.99 price)(1000 bonds)($1,000 face value) − $35,000.

152

On September 1, 2005, Cobb Co. issued a note payable to the National Bank in the amount of $900,000, bearing interest at 12%, and payable in three equal annual principal payments of $300,000.
On this date, the bank's prime rate was 11%. The first payment for interest and principal was made on September 1, 2006.
At December 31, 2006, Cobb should record accrued interest payable of

A. $36,000
B. $33,000
C. $24,000
D. $22,000

C. $24,000
As of 12/31/06, the first $300,000 principal installment has been paid, along with interest. This payment was made 9/1/06. The remaining principal outstanding on that date is $600,000 ($900,000 - $300,000). Thus, accrued interest on 12/31/06 is $24,000 = 600,000(.12)(4/12).

153

During 2002, Lake Co. issued 3,000 of its 9%, $1,000 face value bonds at 101 1/2. In connection with the sale of these bonds, Lake paid the following expenses:

Promotion costs $ 20,000
Engraving and printing 25,000
Underwriters' commissions 200,000
What amount should Lake record as bond issue costs to be amortized over the term of the bonds?

A. $0
B. $220,000
C. $225,000
D. $245,000

D. $245,000
All three listed costs are included in bond issue costs and are amortized over the term of the bonds. All three contribute to the effort of issuing the bonds.

154

Dixon Co. incurred costs of $3,300 when it issued, on August 31, 2005, 5-year debenture bonds dated April 1, 2005.
What amount of bond issue expense should Dixon report in its income statement for the year ended December 31, 2005?

A. $220
B. $240
C. $495
D. $3,300

B. $240
There are four years and seven months in the bond term (5 years less the 5 months from April 1 to August 31) or a total of 55 months. Thus, the 2005 amortization of bond issue costs, which is capitalized as a deferred charge, is $240 [(4/55)$3,300]. The bonds were outstanding four months in 2005.

155

Blue Co. issued preferred stock with detachable common stock warrants at a price which exceeded both the par value and the market value of the preferred stock.
At the time the warrants are exercised, Blue's total stockholders' equity is increased by the

Cash received upon exercise of the warrants Carrying amount of warrant
Yes No
Yes Yes
No No
No Yes

Cash received upon exercise of the warrants Carrying amount of warrant
Yes No
When the preferred stock was issued, a portion of the proceeds was allocated to an owners' equity account for the warrants. When the warrants are exercised, this account, which holds the carrying value of the warrants, is closed.


Cash is increased, and common stock (and possibly contributed capital in excess of par) also is increased to account for the issuance of stock. The net effect on owners' equity of the exercise is, therefore, the amount of cash received.

156

On December 30, 2004, Fort, Inc. issued 1,000 of its 8%, 10-year, $1,000 face value bonds with detachable stock warrants at par.
Each bond carried a detachable warrant for one share of Fort's common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000, and the market value of the warrants was $120,000.

In its December 31, 2004, balance sheet, what amount should Fort report as bonds payable?

A. $1,000,000
B. $975,000
C. $900,000
D. $880,000

C. $900,000
The proceeds of the issue ($1,000,000 because the bonds were issued at par) is allocated based on the relative fair values of the two securities. The total market value of the two securities after issuance is $1,200,000 ($1,080,000 + $120,000). The allocation to the bonds is then $900,000 [($1,080,000/$1,200,000)$1,000,000]

157

Ray Corp. issued bonds with a face amount of $200,000. Each $1,000 bond contained detachable stock warrants for 100 shares of Ray's common stock.
Total proceeds from the issue amounted to $240,000.
The market value of each warrant was $2, and the market value of the bonds without the warrants was $196,000.
The bonds were issued at a discount of

A. $0
B. $678
C. $4,000
D. $33,898

B. $678
The proceeds are allocated based on relative market values:
Market value of bonds:
$196,000
+ market value of warrants: (200 bonds)(100 warrants/bond)($2) =
40,000
= total market value of the securities
$236,000
Allocation to bonds = $240,000($196,000/$236,000) = $199,322. The discount on the bonds is therefore $678 = $200,000 - $199,322.

158

Bonds with detachable stock warrants were issued by Flack Co. Immediately after issue the aggregate market value of the bonds and the warrants exceeds the proceeds.
Is the portion of the proceeds allocated to the warrants less than their market value, and is that amount recorded as contributed capital?

Less than warrants' market value Contributed capital
No Yes
Yes No
Yes Yes
No No

Yes Yes
Because the total market value of the bonds and warrants exceeds the proceeds, and the allocation of the proceeds is based on the relative fair values of the bonds and warrants, a smaller amount (the portion of the proceeds) than market value is allocated to each security. The amount allocated to the warrants is recorded in an OE account such as detachable stock warrants outstanding.

159

Willem Co. reported the following liabilities at December 31, 2001:

Accounts payable-trade $ 750,000
Short-term borrowings 400,000
Mortgage payable, current portion $100,000 3,500,000
Other bank loan, matures June 30, 2002 1,000,000
The $1,000,000 bank loan was refinanced with a 20-year loan on January 15, 2002, with the first principal payment due January 15, 2003. Willem's audited financial statements were issued February 28, 2002. What amount should Willem report as current liabilities at December 31, 2001?

A. $850,000
B. $1,150,000
C. $1,250,000
D. $2,250,000

C. $1,250,000
The $1,000,000 loan was successfully refinanced on a long-term basis and therefore was moved to the noncurrent liability category. The refinancing took place before the financial statements were issued, thus meeting the requirements for reclassification on a long-term basis. The remaining items are all current: $750,000 accounts payable + $400,000 short term borrowings + $100,000 current portion of mortgage payable = $1,250,000 total current liabilities.

160

Cali, Inc., had a $4,000,000 note payable due on March 15, 2006. On January 28, 2006, before the issuance of its 2005 financial statements, Cali issued long-term bonds in the amount of $4,500,000. Proceeds from the bonds were used to repay the note when it came due.
How should Cali classify the note in its December 31, 2005, financial statements?

A. As a current liability, with separate disclosure of the note refinancing.
B. As a current liability, with no separate disclosure required.
C. As a noncurrent liability, with separate disclosure of the note refinancing
D. As a noncurrent liability, with no separate disclosure required

C. As a noncurrent liability, with separate disclosure of the note refinancing

161

Mortgage note payable; $16,000 due within 12 months $355,000
Short-term debt that the company is refinancing with long-term debt 175,000
Deferred tax liability arising from depreciation 25,000
What amount should the company include in the current liability section of the balance sheet?

A. $0
B. $16,000
C. $41,000
D. $191,000

B. $16,000
Only the principal portion of the mortgage note is current. The short-term debt has been refinanced and reclassified as noncurrent. The deferred tax liability relating to depreciation is noncurrent. The classification of a deferred tax account is based on the classification of the underlying account, which in this case is a plant asset (always noncurrent).

162

On December 31, 2004, Largo, Inc. had a $750,000 note payable outstanding, due July 31, 2005.
Largo borrowed the money to finance construction of a new plant. Largo planned to refinance the note by issuing long-term bonds. Because Largo temporarily had excess cash, it prepaid $250,000 of the note on January 12, 2005.
In February 2005, Largo completed a $1,500,000 bond offering. Largo will use the bond offering proceeds to repay the note payable at its maturity and to pay construction costs during 2005.
On March 3, 2005, Largo issued its 2004 financial statements.

What amount of the note payable should Largo include in the current liabilities section of its December 31, 2004 balance sheet?

A. $750,000
B. $500,000
C. $250,000
D. $0

C. $250,000
The portion of the note paid between the balance sheet date and the date of issuing the financial statements is classified as current because current assets were used to retire that part of the note.
Even though proceeds from the bond issue may be used to replenish these funds, the $250,000 payment nonetheless reduced current assets. The remainder of the note is classified as noncurrent because the firm fully intends to refinance the remaining $500,000 with a long-term liability, and has shown its ability to do so by actually issuing bonds for the purpose of refinancing before issuing the financial statements.

Thus, the FAS 6 requirements for reclassifying the remaining $500,000 portion of the current note payable as noncurrent have been met.

163

On June 2, 2000, Tory, Inc. issued $500,000 of 10%, 15-year bonds at par. Interest is payable semiannually on June 1 and December 1. Bond issue costs were $6,000. On June 2, 2005, Tory retired half of the bonds at 98.
What is the net amount that Tory should use in computing the gain or loss on the retirement of debt?

A. $249,000
B. $248,500
C. $248,000
D. $247,000

C. $248,000

Number of semiannual periods in bond term: 15(2) = 30
Number of semiannual periods remaining at 6/2/05 = 10(2) = 20
Remaining unamortized bond issue costs: $6,000(20/30) = $4,000
Net amount to compare to price paid for bonds, to determine gain or loss on retirement, on one-half the bond issue: (1/2)($500,000 - $4,000) = $248,000. A journal entry recording the retirement of one-half the issue helps show why $248,000 is the correct answer.

Bonds payable 250,000
Bond issue costs 2,000
Cash .98($250,000) 245,000
Gain 3,000
The gain equals the net value of two accounts removed from the books ($248,000) less the amount paid to retire the bonds.

164

On June 30, 2000, King Co. had outstanding 9%, $5,000,000 face value bonds maturing on June 30, 2005. Interest was payable semi-annually every June 30 and December 31.
On June 30, 2000, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. On that date, King acquired all its outstanding bonds on the open market at 98 and retired them.

On redemption of the bonds at June 30, 2000, what amount should King recognize as gain before income taxes?

A. $20,000
B. $80,000
C. $120,000
D. $180,000

B. $80,000
A journal entry illustrates the calculation:
Bonds payable
5,000,000
Bond premium
30,000
Bond issue costs
50,000
Cash .98($5,000,000)
4,900,000
Gain
80,000
The unamortized bond issue costs reduce the gain because they are an asset that has no further benefit. The write-off simply reduces the gain. Had there been a net loss, the removal of the bond issue costs would have increased that loss.

165

Weald Co. took advantage of market conditions to refund debt. This was the fifth refunding operation carried out by Weald within the last four years.
The excess of the carrying amount of the old debt over the amount paid to extinguish it should be reported as a(an)

A. Deferred credit to be amortized over life of new debt.
B. Part of continuing operations.
This gain is included in income from continuing operations, as would other gains and losses such as on equipment disposal.
C. Part of other comprehensive income for the year.
D. Loss.

B. Part of continuing operations.

166

On January 1, 2000, Fox Corp. issued 1,000 of its 10%, $1,000 bonds for $1,040,000. These bonds were to mature on January 1, 2010 but were callable at 101 any time after December 31, 2003. Interest was payable semi-annually on July 1 and January 1.
On July 1, 2005, Fox called all of the bonds and retired them.
The bond premium was amortized on a straight-line basis. Before income taxes, Fox's gain or loss in 2005 on this early extinguishment of debt was

A. $30,000 gain.
B. $12,000 gain.
C. $10,000 loss.
D. $8,000 gain

D. $8,000 gain
The portion of the bond term that remains is 4 1/2 years as of July 1, 2005, because the bonds have been outstanding for 5 1/2 years as of that date. Therefore, the book value of the bonds on July 1, 2005 equals the face value of the bonds ($1,000,000) plus the unamortized bond premium of $18,000 = (4.5/10)$40,000, for a total of $1,018,000.
The gain on the bond extinguishment is the difference between the book value and the amount paid to extinguish the bonds: $1,018,000 - 1.01($1,000,000) = $8,000. The gain results because it cost Fox less to retire the bonds than the book value of the bonds.

167

Of the 125,000 shares of common stock issued by Vey Corp., 25,000 shares were held as treasury stock at December 31, 2004. During 2005, transactions involving Vey's common stock were as follows:

January 1 through October 31 - 13,000 treasury shares were distributed to officers as part of a stock compensation plan.

November 1 - A 3-for-1 stock split took effect.

December 1 - Vey purchased 5,000 of its own shares to discourage an unfriendly takeover. These shares were not retired.

At December 31, 2005, how many shares of Vey's common stock were issued and outstanding?

Shares Issued Shares Outstanding
375,000 334,000
375,000 324,000
334,000 334,000
324,000 324,000

Shares Issued Shares Outstanding
375,000 334,000
Issued shares include outstanding shares and treasury shares. Treasury shares are issued but not outstanding. Stock splits are applied to all outstanding and treasury shares because a split reduces the par value of each share of issued stock, and increases the number of shares in inverse proportion.

Assume the stock has a par value of $3 before the split. After the 3-for-1 split in this question, the par value is $1, but the number of shares is tripled. Treasury shares must be adjusted for splits because treasury shares typically are reissued. No shares were retired.

Therefore, the number of issued shares at the end of the year is three times the number at the beginning of the year: 125,000(3) = 375,000 shares issued at December 31, 2005.

Number of shares outstanding at December 31, 2005 = (100,000 + 13,000)3 - 5,000 = 334,000.

Only 100,000 shares were outstanding at the beginning of the year because the 125,000 issued shares includes the 25,000 in the treasury. The split took effect after 13,000 of the 25,000 treasury shares at the beginning of the year were issued. The 5,000 treasury shares purchased at December 1 already reflect the split and are not adjusted further.

168

Kamy Corp. is in liquidation under Chapter 7 of the Federal Bankruptcy Code. The bankruptcy trustee has established a new set of books for the bankruptcy estate. After assuming custody of the estate, the trustee discovered an unrecorded invoice of $1,000 for machinery repairs performed before the bankruptcy filing.
In addition, a truck with a carrying amount of $20,000 was sold for $12,000 cash. This truck was bought and paid for in the year before the bankruptcy.
What amount should be debited to estate equity as a result of these transactions?

A. $0
B. $1,000
C. $8,000
D. $9,000

D. $9,000
The debit to estate equity is the additional expense and loss that had not been previously recorded.
This amount is $9,000 ($1,000 repair cost + $8,000 loss on the truck). The $8,000 loss is the difference between the $20,000 carrying amount and the $12,000 proceeds.

169

Which of the following errors could result in an overstatement of both current assets and stockholders' equity?
A. An understatement of accrued sales expenses.
B. Noncurrent note receivable principal is misclassified as a current asset.
C. Annual depreciation on manufacturing machinery is understated.
D. Holiday pay expense for administrative employees is misclassified as manufacturing overhead.

D. Holiday pay expense for administrative employees is misclassified as manufacturing overhead.
This error reduces expenses because part of the holiday pay will be held back in ending inventory, which is a current asset. Thus, net income, and therefore OE are overstated, as well as ending inventory, which is a current asset.

170

Nest Co. issued 100,000 shares of common stock. Of these, 5,000 were held as treasury stock at December 31, 2004. During 2005, transactions involving Nest's common stock were as follows:
May 3 - 1,000 shares of treasury stock were sold.
August 6 - 10,000 shares of previously unissued stock were sold.
November 18 - A 2-for-1 stock split took effect.
Laws in Nest's state of incorporation protect treasury stock from dilution. At December 31, 2005, how many shares of Nest's common stock were issued and outstanding?

Shares Issued Shares Outstanding
220,000 212,000
220,000 216,000
222,000 214,000
222,000 218,000

Shares Issued Shares Outstanding
220,000 212,000
Treasury shares are considered issued, but not outstanding. At December 31, 2005:
Number of shares issued = [100,000 (beginning) + 10,000 (new issuance)]2 = 220,000.

Number of shares outstanding =
[95,000 (beginning) + 1,000 TS reissuance + 10,000 (new issuance)]2 = 212,000.

171

Choose the correct statement regarding the accounting treatment of troubled debt restructures (TDRs) under international accounting standards (IAS).
A. Settlements are treated the same way as under U.S. standards.
B. Modification of terms TDRs are treated the same way as under U.S. standards.
C. A significant modification of terms for IAS is treated as a modification of terms type II under U.S. standards.
D. A non-significant modification of terms for IAS is treated as a modification of terms type I under U.S. standards.

A. Settlements are treated the same way as under U.S. standards.

Both sets of standards treat settlements as extinguishments with a gain to the debtor for the difference between debt book value and fair value of consideration paid.

172

A debtor and a creditor have negotiated new terms on a note. How can you determine whether the restructuring is a troubled debt restructure?
A. If the interest rate as stated in the restructuring agreement has been reduced relative to the original loan agreement
B. If the present value of the restructured flows using the original interest rate is less than the book value of the debt at the date of the restructure.
C. If the interest rate that equates (1) the book value of the debt at the date of the restructure and (2) the present value of restructured cash flows, exceeds the original interest rate
D. If the present value of the restructured flows using the original interest rate is less than the market value of the original debt at the date of the restructure

B. If the present value of the restructured flows using the original interest rate is less than the book value of the debt at the date of the restructure.

173

For a troubled debt restructuring involving only a modification of terms, which of the following items specified by the new terms would be compared to the carrying amount of the debt to determine if the debtor should report a gain on restructuring?
A. The total future cash payments.
B. The present value of the debt at the original interest rate.
C. The present value of the debt at the modified interest rate
D. The amount of future cash payments designated as principal repayments

For a troubled debt restructuring involving only a modification of terms, which of the following items specified by the new terms would be compared to the carrying amount of the debt to determine if the debtor should report a gain on restructuring?
A. The total future cash payments.

174

On December 30, 2004, Hale Corp. paid $400,000 cash and issued 80,000 shares of its $1 par value common stock to its unsecured creditors on a pro rata basis pursuant to a reorganization plan under Chapter 11 of the bankruptcy statutes. Hale owed these unsecured creditors a total of $1,200,000. Hale's common stock was trading at $1.25 per share on December 30, 2004.
As a result of this transaction, Hale's total stockholders' equity had a net increase of

A. $1,200,000
B. $800,000
C. $100,000
D. $80,000

B. $800,000
The market value of the stock issued to the creditors is $100,000 (80,000 x $1.25). The fair value of consideration paid to settle the debt therefore is $500,000 ($400,000 cash + $100,000 of stock). The gain on settling the debt therefore is $700,000 ($1,200,000 - $500,000 total consideration).
The gain increases owners' equity by way of net income. The issuance of stock is recorded at market value, $100,000. Thus, the total owners' equity increase is $800,000 ($700,000 + $100,000). Note that this amount is also the difference between the amount of debt retired ($1,200,000) and cash paid ($400,000).

175

The following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by Knob Co. to Mene Corp. in full liquidation of Knob's liability to Mene:

Carrying amount of liability liquidated
$150,000
Carrying amount of real estate transferred
100,000
Fair value of real estate transferred
90,000
What amount should Knob report as an ordinary gain (loss) on transfer on disposal?

A. ($10,000)
B. $0
C. $50,000
D. $60,000

A. ($10,000)
The real estate transferred in settlement of the debt is worth $10,000 less than its carrying value. Thus, an ordinary loss is recognized on the transfer. It is as if Knob first sold the real estate for $90,000 causing a loss of $10,000, and then used the cash for settlement of the debt.

176

Nu Corp. agreed to give Rand Co. a machine in full settlement of a note payable to Rand. The machine's original cost was $140,000. The note's face amount was $110,000. On the date of the agreement,

the note's carrying amount was $105,000, and its present value was $96,000.
The machine's carrying amount was $109,000, and its fair value was $96,000.
What amount of net gain (or losses) should Nu recognize?

A. ($4,000)
B. $0
C. ($13,000)
D. $9,000

A. ($4,000)
The net loss listed is the difference between the carrying amount of the liability and the carrying amount of the machine. Nu has a gain of $9,000 on the note settlement, which is the difference between the liability carrying value ($105,000) and the fair value of the consideration given to extinguish the debt ($96,000). Nu also has a disposal loss on the machine. An ordinary loss of $13,000 is recognized and equals the difference between the machine's carrying value ($109,000) and its fair value ($96,000).

177

When preparing a draft of its 2005 balance sheet, Mont, Inc. reported net assets totaling $875,000. Included in the asset section of the balance sheet were the following:
Treasury stock of Mont, Inc. at cost, which approximates market value on December 31 $24,000
Idle machinery 11,200
Cash surrender value of life insurance on corporate executives 13,700
Allowance for decline in market value of noncurrent equity investments 8,400

At what amount should Mont's net assets be reported in the December 31, 2005 balance sheet?
A. $851,000
B. $850,100
C. $842,600
D. $834,500

A. $851,000
Preadjusted asset total $875,000
Less Mont stock (24,000)
Corrected total assets $851,000
A firm's treasury stock is not an asset of that firm. A firm cannot own its own stock. The other items listed are appropriately included in assets.

178

Hoyt Corp.'s current balance sheet reports the following stockholders' equity:

5% cumulative preferred stock, par value $100 per share; 2,500 shares issued and outstanding $250,000
Common stock, par value $3.50 per share; 100,000 shares issued and outstanding 350,000
Additional paid-in capital in excess of par value of common stock 125,000
Retained earnings 300,000
Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, the preferred stockholders would receive par value plus a premium of $50,000. The book value of common stock is

A. $7.75
B. $7.50
C. $7.25
D. $7.00

D. $7.00

250+350+125-25 in dividends in arrears = 700/100 CS shares = $7.00.

179

A company whose stock is trading at $10 per share has 1,000 shares of $1 par common stock outstanding when the board of directors declares a 30% common stock dividend. Which of the following adjustments should be made when recording the stock dividend?
A. Treasury stock is debited for $300.
B. Additional paid-in capital is credited for $2,700.
C. Retained earnings is debited for $300.
D. Common stock is debited for $3,000.

C. Retained earnings is debited for $300.
This is a large stock dividend (> 25%); therefore retained earnings is debited for par value. The amount is the par value of the shares distributed in the dividend, or 1,000(.30)($1) = $300. The credit is to common stock for the shares issued.

180

In September 2001, West Corp. made a dividend distribution of one right for each of its 120,000 shares of outstanding common stock.
Each right was exercisable for the purchase of one-hundredth of a share of West's $50 variable-rate preferred stock at an exercise price of $80 per share. On March 20, 2005, none of the rights had been exercised, and West redeemed them by paying each stockholder $0.10 per right.

As a result of this redemption, West's stockholders' equity was reduced by

A. $120
B. $2,400
C. $12,000
D. $36,000

C. $12,000
The dividend did not affect total OE, because no resources were expended or received. The payment of $0.10 per right reduces OE by a total of 120,000($0.10) = $12,000, because this amount of cash was paid.

181

A company issued rights to its existing shareholders without consideration. The rights allowed the recipients to purchase unissued common stock for an amount in excess of par value.
When the rights are issued, which of the following accounts will be increased?

Common stock Additional paid-in capital
Yes Yes
Yes No
No No
No Yes

Common stock Additional paid-in capital
No No
There is no effect on OE when rights are issued to existing stockholders pursuant to a future stock issuance. No journal entry is needed, because no transaction has yet taken place.

182

The stockholders' equity section of Brown Co.'s December 31, 2005 balance sheet consisted of the following:
Common stock, $30 par, 10,000 shares authorized and outstanding $300,000
Additional paid-in capital 150,000
Retained earnings (deficit) (210,000)
On January 2, 2006, Brown put into effect a stockholder-approved quasi-reorganization by reducing the par value of the stock to $5 and eliminating the deficit against additional paid-in capital. Immediately after the quasi-reorganization, what amount should Brown report as additional paid-in capital?

A. $(60,000)
B. $150,000
C. $190,000
D. $400,000

C. $190,000
Reducing the par value to $5 creates $250,000 of additional paid-in capital: ($30 - $5)10,000 shares = $250,000. The common stock account is now $50,000: ($5)10,000.
Additional paid-in capital now stands at $400,000 ($150,000 + $250,000).

After absorbing the deficit in retained earnings, $190,000 remains in additional paid-in capital: ($400,000 - $210,000). Retained earnings are now zero.

183

At December 31, 2004 and 2005, Apex Co. had 3,000 shares of $100 par, 5% cumulative preferred stock outstanding. No dividends were in arrears as of December 31, 2003. Apex did not declare a dividend during 2004. During 2005, Apex paid a cash dividend of $10,000 on its preferred stock.
Apex should report dividends in arrears in its 2005 financial statements as a(an)

A. Accrued liability of $15,000.
B. Disclosure of $15,000.
C. Accrued liability of $20,000.
D. Disclosure of $20,000.

D. Disclosure of $20,000.
The annual preferred stock dividend is $15,000 (3,000 x $100 x 5%). Total dividends in arrears at the end of 2005 are therefore $20,000 (2 years x $15,000 - $10,000 paid). Dividends in arrears are footnoted only. They are not recognized as a liability until they are declared.

184

On December 1, 2005, Nilo Corp. declared a property dividend of marketable securities to be distributed on December 31, 2005, to stockholders of record on December 15, 2005. On December 1, 2005, the marketable securities had a carrying amount of $60,000 and a fair value of $78,000.
What is the effect of this property dividend on Nilo's 2005 retained earnings, after all nominal accounts are closed?

A. $0
B. $18,000 increase.
C. $60,000 decrease.
D. $78,000 decrease.

C. $60,000 decrease.
The net decrease in retained earnings is $60,000 ($78,000 - $18,000).

185

500 shares of 6%, $100 par callable preferred stock are called at $101. The shares were issued at $103 per share. The journal entry to record the retirement includes which of the following?
A. Cr. paid in capital from retirement of preferred stock, $1,000.
B. Dr. paid in capital from retirement of preferred stock $1,500.
C. Cr. retained earnings $1,000
D. Dr. preferred stock $51,500

A. Cr. paid in capital from retirement of preferred stock, $1,000.
The $2 difference multiplied by 500 shares yields $1,000 paid in capital kept by the firm. The journal entry is:
DR: Preferred stock 500($100) 50,000
DR: PIC-preferred 500($103 - $100) 1,500
CR: PIC-retirement of preferred 1,000
CR: Cash 500($101) 50,500

186

An individual contracts for the purchase of 200 shares of $10 par common stock at a subscription price of $15. After making payments totaling $1,200, the subscriber defaults. Shares are issued in proportion to the amount of cash paid by the investor. The summary journal entry to record the net effect of these two transactions includes:

A. Debit share purchase contract receivable $1,800.
B. Credit common stock $2,000
C. Credit paid in capital in excess of par on common, $400
D. Credit share purchase contract receivable $600

C. Credit paid in capital in excess of par on common, $400
The net effect of the transactions is to receive cash of $1,200 and issue stock for that amount at $15/share; $1,200/$15 = 80 shares fully paid. Required net changes in balances are (1) common stock, 80($10) = $800, (2) PIC-CS, 80($15 - $10) = $400, (3) cash $1,200. The share purchase contract receivable account is opened and then closed for the same amount. There is no ending balance in that account.

187

When collectability is reasonably assured, the excess of the subscription price over the stated value of the no par common stock subscribed should be recorded as
A. No par common stock.
B. Additional paid-in capital when the subscription is recorded
C. Additional paid-in capital when the subscription is collected
D. Additional paid-in capital when the common stock is issued

B. Additional paid-in capital when the subscription is recorded

188

On July 1, 2005, Cove Corp., a closely-held corporation, issued 6% bonds with a maturity value of $60,000, together with 1,000 shares of its $5 par value common stock, for a combined cash amount of $110,000.
The market value of Cove's stock cannot be ascertained. If the bonds were issued separately, they would have sold for $40,000 on an 8% yield to maturity basis.

What amount should Cove report for additional paid-in capital on the issuance of the stock?

A. $75,000
B. $65,000
C. $55,000
D. $45,000

B. $65,000
The amount of the proceeds allocated to the stock is $70,000 ($110,000 - $40,000). When only one of the two securities has a known market value, that value is allocated to that security and the remaining proceeds are allocated to the security without a known market value.
The total par value of 1,000 shares of $5 par stock is $5,000. Therefore, $65,000 ($70,000 - $5,000) is recorded in additional paid-in capital on common stock.

189

On March 1, 2005, Rya Corp. issued 1,000 shares of its $20 par value common stock and 2,000 shares of its $20 par value convertible preferred stock for a total of $80,000.
At this date, Rya's common stock was selling for $36 per share, and the convertible preferred stock was selling for $27 per share.
What amount of the proceeds should be allocated to Rya's convertible preferred stock?

A. $60,000
B. $54,000
C. $48,000
D. $44,000

C. $48,000
The total proceeds are allocated to the two securities based on relative market values.
Market value of common: 1,000($36) = $36,000
Market value of preferred: 2,000($27) = 54,000
Total market value $90,000
Allocation of proceeds to preferred = ($54,000/$90,000) * $80,000 = $48,000

190

The owners' equity section of a firm includes (1) $10,000 of 8%, $100 par cumulative preferred stock, and (2) $40,000 of $5 par common stock. There is additional paid-in capital on both issues. The preferred is fully participating and there are two years of dividends in arrears as of the beginning of the current year. If the firm pays $30,000 in dividends, what amount is allocated to common?
A. $23,360
B. $22,720
C. $22,080
D. $24,320

B. $22,720
Preferred represents one-fifth of total par value outstanding ($10,000/$50,000).
To Preferred To Common
Arrearage .08(2)($10,000) = $1,600
Current year .08($10,000) = 800
Matching .08($40,000) = $3,200
Dividends remaining = $30,000 - $1,600 - $800 - $3,200 = $24,400, which is allocated according to total par value.
Participation one-fifth($24,400) = 4,880
four-fifths($24,400) = 19,520
Total $7,280 $22,720

191

Arp Corp.'s outstanding capital stock at December 15, 2005 consisted of the following:
30,000 shares of 5% cumulative preferred stock, par value $10 per share, fully participating as to dividends. No dividends were in arrears.
200,000 shares of common stock, par value $1 per share.
On December 15, 2005, Arp declared dividends of $100,000. What was the amount of dividends payable to Arp's common stockholders?

A. $10,000
B. $34,000
C. $40,000
D. $47,500

C. $40,000
Participating dividends are allocated according to total par value after each class of stock receives the preferred dividend percentage.
Total par value of preferred stock outstanding is $300,000 (30,000 x $10), and total par value of common stock outstanding is $200,000 (200,000 x $1). Total par value of all stock outstanding is therefore $500,000. Preferred is three-fifths of total par value outstanding ($300,000/$500,000) and common is two-fifths ($200,000/$500,000) of total par value outstanding.

2005 preferred requirement: 30,000(.05)($10) = $15,000
Preferred percentage to common: .05(200,000)($1) = 10,000 --> $10,000
Subtotal $25,000
Remaining dividends: $100,000 - $25,000 = $75,000
Participation to preferred, based on total par value:
$75,000(3/5) = $45,000
Participation to common, based on total par value:
$75,000(2/5) = 30,000 ---------------------> 30,000
Total common dividends $40,000

192

When a company goes through a quasi-reorganization, its balance sheet carrying amounts are stated at:
A. Original cost.
B. Original book value.
C. Replacement value.
D. Fair value.

D. Fair value.

193

Grid Corp. acquired some of its own common shares at a price greater than both their par value and original issue price, but less than their book value. Grid uses the cost method of accounting for treasury stock.
What is the impact of this acquisition on total stockholders' equity and the book value per common share?

Total stockholders' equity Book value per share
Increase Increase
Increase Decrease
Decrease Increase
Decrease Decrease

Total stockholders' equity Book value per share Decrease Increase
The purchase of treasury stock at any price decreases total owners' equity under the cost method because treasury stock is a contra OE account. When the purchase price per share is less than book value per share, then the denominator decreases by a greater percentage than does the numerator, and book value per share increases.

For example, assume for simplicity that there is only common stock outstanding. Total owners' equity and number of shares before the treasury stock purchase is $40,000 and 4,000, respectively. Book value per share then is $10. The firm purchases 200 shares of treasury stock for $8 (less than book value). The new book value per share is:

($40,000 - $1,600)/(3,800) = $10.11. Book value per share has increased.

194

Asp Co. was organized on January 2, 2005 with 30,000 authorized shares of $10 par common stock. During 2005, the corporation had the following capital transactions:
January 5 - issued 20,000 shares at $15 per share.
July 14 - Purchased 5,000 shares at $17 per share.
December 27 - Reissued the 5,000 shares held in treasury at $20 per share.
Asp Used the par value method to record the purchase and reissuance of the treasury shares. In its December 31, 2005 balance sheet, what amount should Asp report as additional paid-in capital in excess of par?

A. $100,000
B. $125,000
C. $140,000
D. $150,000

B. $125,000
Journal entries for the three transactions provide the ending balance in additional paid-in capital.
Under the par method of accounting for treasury stock, the amount of additional paid-in capital FROM ORIGINAL ISSUANCE is reduced when treasury stock is purchased. When treasury stock is reissued, additional paid-in capital is credited for the amount in excess of par, just as in the issuance of unissued shares.

Cash 300,000 20,000(15)
Common Stock 200,000 20,000(10)
Addl paid-in capital 100,000 20,000(15-10)
Treasury stock 50,000 5,000(10)
Addl paid-in capital 25,000 5,000(15-10)
Retained earnings 10,000 5,000(17-15)
Cash 85,000 5,000(17)
Cash 100,000 5,000(20)
Treasury stock 50,000 5,000(10)
Addl paid-in capital 50,000 5,000(20-10)
The ending balance in additional paid-in capital after these transactions is $125,000. Retained earnings was reduced in the second transaction because no additional paid-in capital from treasury stock existed at that point.

195

In 2003, Fogg, Inc. issued $10 par value common stock for $25 per share. No other common stock transactions occurred until March 31, 2005, when Fogg acquired some of the issued shares for $20 per share and retired them.
Which of the following statements correctly states an effect of this acquisition and retirement?

A. 2005 net income is decreased.
B. 2005 net income is increased.
C. Additional paid-in capital is decreased
D. Retained earnings is increased

C. Additional paid-in capital is decreased

196

On December 1, 2004, Line Corp. received a donation of 2,000 shares of its $5 par value common stock from a stockholder. On that date, the stock's market value was $35 per share. The stock was originally issued for $25 per share.
By what amount would this donation cause total stockholders' equity to decrease?

A. $70,000
B. $50,000
C. $20,000
D. $0.

D. $0
The shares are considered donated treasury shares. Treasury stock and a gain or revenue account are increased by the market value of the stock received in donation (FAS 116). The increase in the treasury stock account decreases the owners' equity, but the gain or revenue increases the owners' equity by the same amount. Therefore, there is no net effect on the owners' equity.

197

On December 31, 2004, Pack Corp.'s Board of Directors canceled 50,000 shares of $2.50 par value common stock held in treasury at an average cost of $13 per share. Before recording the cancellation of the treasury stock, Pack had the following balances in its stockholders' equity accounts:

Common stock $540,000
Additional paid-in capital 750,000
Retained earnings 900,000
Treasury stock, at cost 650,000
In its balance sheet at December 31, 2004, Pack should report common stock outstanding of

A. $0
B. $250,000
C. $415,000
D. $540,000

C. $415,000
When treasury stock is cancelled (retired), the common stock account is reduced by the par value of the common stock cancelled. The ending common stock account balance is $415,000 = $540,000 -

198

On incorporation, Dee Inc. issued common stock at a price in excess of its par value. No other stock transactions occurred except treasury stock was acquired for an amount exceeding this issue price.
If Dee uses the par value method of accounting for treasury stock appropriate for retired stock, what is the effect of the acquisition on the following?

Net comm. stock APIC Retained earnings
No effect Decrease No effect
Decrease Decrease Decrease
Decrease No effect Decrease
No effect Decrease Decrease

Decrease Decrease Decrease
Under the par value method, when treasury stock is purchased and retired at a price exceeding the original issue price, the following entry is made. No additional paid-in capital from treasury stock transactions exists. Therefore, retained earnings is debited. Common stock par Additional paid-in capital original issue price - par Retained earnings acquisition price - original issuance price Cash acquisition price. Thus, all three accounts listed in the question are decreased.

199

The acquisition of treasury stock will cause the number of shares outstanding to decrease if the treasury stock is accounted for by the
Cost method Par value method
Yes No
No No
Yes Yes
No Yes

Yes Yes
The acquisition of treasury stock reduces the number of shares of stock outstanding, regardless of the method used to account for the treasury stock.
Shares in the treasury are considered issued, but not outstanding.